Sales and Other Important Reminders · Example 1.Assume the same facts as inabout the foreclosure...

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Publication 544 ContentsCat. No. 15074K

Important Reminders . . . . . . . . . . . . . . 1Departmentof the Introduction . . . . . . . . . . . . . . . . . . . . . 2Sales and OtherTreasury

1. Gain or Loss . . . . . . . . . . . . . . . . . . 2InternalSales and Exchanges . . . . . . . . . . . . 2Revenue Dispositions ofAbandonments . . . . . . . . . . . . . . . . 4ServiceForeclosures and Repossessions . . . . 4Involuntary Conversions . . . . . . . . . . 5Assets Nontaxable Exchanges . . . . . . . . . . . 10Transfers to Spouse . . . . . . . . . . . . . 17Rollover of Gain From Publicly

Traded Securities . . . . . . . . . . . . 18For use in preparing Sales of Small Business Stock . . . . . . 18Rollover of Gain From Sale of

Empowerment Zone Assets . . . . . 182004 ReturnsExclusion of Gain from Sale of

DC Zone Assets . . . . . . . . . . . . . 18

2. Ordinary or Capital Gain orLoss . . . . . . . . . . . . . . . . . . . . . . . 19Capital Assets . . . . . . . . . . . . . . . . . 19Noncapital Assets . . . . . . . . . . . . . . 19Sales and Exchanges Between

Related Persons . . . . . . . . . . . . 20Other Dispositions . . . . . . . . . . . . . . 21

3. Ordinary or Capital Gain orLoss for Business Property . . . . . . . 24Section 1231 Gains and Losses . . . . . 25Depreciation Recapture . . . . . . . . . . . 25

4. Reporting Gains and Losses . . . . . . . 32Information Returns . . . . . . . . . . . . . 32Schedule D (Form 1040) . . . . . . . . . . 32Form 4797 . . . . . . . . . . . . . . . . . . . 34Example . . . . . . . . . . . . . . . . . . . . . 34

5. How To Get Tax Help . . . . . . . . . . . . 38

Index . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Important RemindersAdditional special depreciation allowances.The 30% and 50% special depreciation al-lowances will not apply to most property placedin service after 2004. However, the special de-preciation allowances are subject to deprecia-tion recapture. See Depreciation Recapture inchapter 3.

Sale of DC Zone assets. If you sold or ex-changed a District of Columbia Enterprise Zone(DC Zone) asset that you held for more than 5years, you may be able to exclude the “qualifiedcapital gain”. For more information, see Exclu-sion of Gain From Sale of DC Zone Assets at theend of chapter 1.

Dispositions of U.S. real property interestsby foreign persons. If you are a foreign per-Get forms and other information son or firm and you sell or otherwise dispose of aU.S. real property interest, the buyer (or otherfaster and easier by:transferee) may have to withhold income tax onthe amount you receive for the property (includ-Internet • www.irs.goving cash, the fair market value of other property,and any assumed liability). Corporations, part-FAX • 703–368–9694 (from your fax machine) nerships, trusts, and estates also may have towithhold on certain U.S. real property interests



they distribute to you. You must report these Forms to file. When you dispose of property, ❏ 954 Tax Incentives for Distressedyou usually will have to file one or more of the Communitiesdispositions and distributions and any incomefollowing forms.tax withheld on your U.S. income tax return.

Form (and Instructions)For more information on dispositions of U.S. • Schedule D (Form 1040), Capital Gainsreal property interests, see Publication 519, U.S. and Losses. ❏ Schedule D (Form 1040) Capital GainsTax Guide for Aliens. and Losses• Form 4797, Sales of Business Property.Foreign source income. If you are a U.S. ❏ 1040 U.S. Individual Income Tax Return• Form 8824, Like-Kind Exchanges.citizen with income from dispositions of property

❏ 1040X Amended U.S. Individual Incomeoutside the United States (foreign income), you Chapter 4 illustrates how to fill out Form 4797 Tax Returnmust report all such income on your tax return and Form 8824.❏ 1099-A Acquisition or Abandonment ofunless it is exempt from U.S. law. This is true

Comments and suggestions. We welcome Secured Propertywhether you reside inside or outside the Unitedyour comments about this publication and yourStates and whether or not you receive a Form ❏ 1099-C Cancellation of Debtsuggestions for future editions.1099 from the foreign payor.

You can write to us at the following address. ❏ 4797 Sales of Business PropertyPhotographs of missing children. The Inter-

❏ 8824 Like-Kind ExchangesInternal Revenue Servicenal Revenue Service is a proud partner with theBusiness Forms and Publications BranchNational Center for Missing and Exploited Chil- See chapter 5 for information about gettingSE:W:CAR:MP:T:Bdren. Photographs of missing children selected publications and forms.1111 Constitution Ave. NWby the Center may appear in this publication onWashington, DC 20224pages that would otherwise be blank. You can

help bring these children home by looking at theWe respond to many letters by telephone.photographs and calling 1-800-THE-LOST Sales and ExchangesTherefore, it would be helpful if you would in-(1-800-843-5678) if you recognize a child.

clude your daytime phone number, including theThe following discussions describe the kinds of

area code, in your correspondence.transactions that are treated as sales or ex-

You can email us at *[email protected]. (Thechanges and explain how to figure gain or loss.

asterisk must be included in the address.)Introduction A sale is a transfer of property for money or aPlease put “Publications Comment” on the sub-

mortgage, note, or other promise to pay money.This publication explains the tax rules that apply ject line. Although we cannot respond individu-An exchange is a transfer of property for other

when you dispose of property. It discusses the ally to each email, we do appreciate yourproperty or services.

feedback and will consider your comments asfollowing topics.we revise our tax products. Sale or lease. Some agreements that seem to

• How to figure a gain or loss. be leases may really be conditional sales con-tracts. The intention of the parties to the agree-• Whether your gain or loss is ordinary orment can help you distinguish between a salecapital.and a lease.

• How to treat your gain or loss when you There is no test or group of tests to provedispose of business property. what the parties intended when they made the1. agreement. You should consider each agree-• How to report a gain or loss.

ment based on its own facts and circumstances.For more information on leases, see chapter 4 inThis publication also explains whether yourPublication 535, Business Expenses.gain is taxable or your loss is deductible. Gain or Loss

This publication does not discuss certain Cancellation of a lease. Payments receivedtransactions covered in other IRS publications. by a tenant for the cancellation of a lease areThese include the following. treated as an amount realized from the sale ofTopics

property. Payments received by a landlord (les-This chapter discusses:• Most transactions involving stocks, bonds, sor) for the cancellation of a lease are essen-options, forward and futures contracts, tially a substitute for rental payments and are• Sales and exchangesand similar investments, discussed in taxed as ordinary income in the year in whichchapter 4 of Publication 550, Investment • Abandonments they are received.Income and Expenses. • Foreclosures and repossessions Copyright. Payments you receive for granting

• Sale of your main home, discussed in the exclusive use of (or right to exploit) a copy-• Involuntary conversionsPublication 523, Selling Your Home. right throughout its life in a particular medium

• Nontaxable exchanges are treated as received from the sale of property.• Installment sales, discussed in PublicationIt does not matter if the payments are a fixed• Transfers to spouse537, Installment Sales.amount or a percentage of receipts from the

• Rollovers and exclusions for certain capi-• Transfers of property at death, discussed sale, performance, exhibition, or publication oftal gainsin Publication 559, Survivors, Executors, the copyrighted work, or an amount based on

and Administrators. the number of copies sold, performances given,or exhibitions made. Nor does it matter if theUseful Itemspayments are made over the same period asDisposing of property. You dispose of prop- You may want to see:that covering the grantee’s use of the copy-erty when any of the following occurs.righted work.Publication• You sell property. If the copyright was used in your trade orbusiness and you held it longer than a year, the❏ 523 Selling Your Home• You exchange property for other property.gain or loss may be a section 1231 gain or loss.

❏ 537 Installment Sales• Your property is condemned or disposed For more information, see Section 1231 Gainsof under threat of condemnation. and Losses in chapter 3.❏ 547 Casualties, Disasters, and Thefts

• Your property is repossessed. Easement. The amount received for granting❏ 550 Investment Income and Expensesan easement is subtracted from the basis of the• You abandon property. ❏ 551 Basis of Assets property. If only a specific part of the entire tract

• You give property away. ❏ 908 Bankruptcy Tax Guide of property is affected by the easement, only the

Page 2 Chapter 1 Gain or Loss



basis of that part is reduced by the amount Basis. You must know the basis of your prop- or other disposition of property held for personalerty to determine whether you have a gain or use is not deductible, except in the case of areceived. If it is impossible or impractical to sep-loss from its sale or other disposition. The basis casualty or theft.arate the basis of the part of the property onof property you buy is usually its cost. However,which the easement is granted, the basis of the

Interest in property. The amount you realizeif you acquired the property by gift, inheritance,whole property is reduced by the amount re-from the disposition of a life interest in property,or in some way other than buying it, you mustceived.an interest in property for a set number of years,use a basis other than its cost. See Basis OtherAny amount received that is more than theor an income interest in a trust is a recognizedThan Cost in Publication 551.basis to be reduced is a taxable gain. The trans-gain under certain circumstances. If you re-

action is reported as a sale of property. Adjusted basis. The adjusted basis of ceived the interest as a gift, inheritance, or in aIf you transfer a perpetual easement for con- property is your original cost or other basis plus transfer from a spouse or former spouse inci-

sideration and do not keep any beneficial inter- certain additions and minus certain deductions, dent to a divorce, the amount realized is a recog-est in the part of the property affected by the such as depreciation and casualty losses. See nized gain. Your basis in the property iseasement, the transaction will be treated as a Adjusted Basis in Publication 551. In determin- disregarded. This rule does not apply if all inter-sale of property. However, if you make a quali- ing gain or loss, the costs of transferring prop- ests in the property are disposed of at the samefied conservation contribution of a restriction or erty to a new owner, such as selling expenses, time.easement granted in perpetuity, it is treated as a are added to the adjusted basis of the property.charitable contribution and not a sale or ex- Example 1. Your father dies and leaves his

Amount realized. The amount you realizechange, even though you keep a beneficial in- farm to you for life with a remainder interest tofrom a sale or exchange is the total of all moneyterest in the property affected by the easement. your younger brother. You decide to sell your lifeyou receive plus the fair market value of allIf you grant an easement on your property interest in the farm. The entire amount you re-property or services you receive. The amount(for example, a right-of-way over it) under con- ceive is a recognized gain. Your basis in theyou realize also includes any of your liabilitiesdemnation or threat of condemnation, you are farm is disregarded.that were assumed by the buyer and any liabili-considered to have made a forced sale, eventies to which the property you transferred isthough you keep the legal title. Although you Example 2. The facts are the same as insubject, such as real estate taxes or a mortgage.figure gain or loss on the easement in the same Example 1, except that your brother joins you in

If the liabilities relate to an exchange of multi-way as a sale of property, the gain or loss is selling the farm. The entire interest in the prop-ple properties, see Treatment of liabilities undertreated as a gain or loss from a condemnation. erty is sold, so your basis in the farm is notMultiple Property Exchanges, later. disregarded. Your gain or loss is the differenceSee Gain or Loss From Condemnations, later.

between your share of the sales price and yourFair market value. Fair market value (FMV)Property transferred to satisfy debt. A adjusted basis in the farm.is the price at which the property would changetransfer of property to satisfy a debt is an ex- hands between a buyer and a seller when both

Canceling a sale of real property. If you sellchange. have reasonable knowledge of all the necessaryreal property under a sales contract that allowsfacts and neither has to buy or sell. If parties withthe buyer to return the property for a full refundNote’s maturity date extended. The exten- adverse interests place a value on property in anand the buyer does so, you may not have tosion of a note’s maturity date is not treated as an arm’s-length transaction, that is strong evidencerecognize gain or loss on the sale. If the buyerexchange of an outstanding note for a new and of FMV. If there is a stated price for services, thisreturns the property in the year of sale, no gaindifferent note. Also, it is not considered a closed price is treated as the FMV unless there is evi-or loss is recognized. This cancellation of theand completed transaction that would result in a dence to the contrary.sale in the same year it occurred places bothgain or loss. However, an extension will beyou and the buyer in the same positions youtreated as a taxable exchange of the outstand- Example. You used a building in your busi-were in before the sale. If the buyer returns theing note for a new and materially different note if ness that cost you $70,000. You made certainproperty in a later tax year, however, you mustthe changes in the terms of the note are signifi- permanent improvements at a cost of $20,000recognize gain (or loss, if allowed) in the year ofcant. Each case must be determined by its own and deducted depreciation totaling $10,000.the sale. When the property is returned in a laterfacts. You sold the building for $100,000 plus propertyyear, you acquire a new basis in the property.having an FMV of $20,000. The buyer assumedThat basis is equal to the amount you pay to theTransfer on death. The transfer of property to your real estate taxes of $3,000 and a mortgagebuyer.an executor or administrator on the death of an of $17,000 on the building. The selling expenses

individual is not a sale or exchange. were $4,000. Your gain on the sale is figured asfollows. Bargain SaleBankruptcy. Generally, a transfer of property

from a debtor to a bankruptcy estate is not Amount realized: If you sell or exchange property for less than fairtreated as a sale or exchange. For more infor- Cash . . . . . . . . . . . $100,000 market value with the intent of making a gift, themation, see The Bankruptcy Estate in Publica- FMV of property 20,000transaction is partly a sale or exchange andtion 908. received . . . . . . . . .partly a gift. You have a gain if the amountReal estate taxesrealized is more than your adjusted basis in theassumed by buyer . . 3,000Gain or Loss From property. However, you do not have a loss if theMortgage assumed bySales and Exchanges amount realized is less than the adjusted basisbuyer . . . . . . . . . . . 17,000 $140,000of the property.Adjusted basis:

Gain or loss is usually realized when property is Cost of building . . . . $70,000Bargain sales to charity. A bargain sale ofsold or exchanged. A gain is the amount you Improvements . . . . . 20,000property to a charitable organization is partly arealize from a sale or exchange of property that Total . . . . . . . . . . . . $90,000sale or exchange and partly a charitable contri-is more than its adjusted basis. A loss is the Minus: Depreciation 10,000bution. If a charitable deduction for the contribu-adjusted basis of the property that is more than Adjusted basis . . . . . $80,000tion is allowable, you must allocate yourthe amount you realize. Plus: Selling expenses 4,000 $84,000adjusted basis in the property between the partGain on sale . . . . . . . . . . . . . . . $56,000

Table 1-1. How To Figure Whether sold and the part contributed based on the fairmarket value of each. The adjusted basis of theYou Have a Gain or Loss Amount recognized. Your gain or loss real-part sold is figured as follows.ized from a sale or exchange of property is

IF your... THEN you have a... usually a recognized gain or loss for tax pur-Adjusted basis of Amount realized

poses. Recognized gains must be included inAdjusted basis is more entire property X (fair market value of part sold)than the amount gross income. Recognized losses are deducti-

Fair market value of entirerealized, Loss. ble from gross income. However, your gain orpropertyloss realized from certain exchanges of propertyAmount realized is more

is not recognized for tax purposes. See Nontax- Based on this allocation rule, you will have athan the adjusted basis, Gain.able Exchanges, later. Also, a loss from the sale gain even if the amount realized is not more than

Chapter 1 Gain or Loss Page 3



your adjusted basis in the property. This alloca- ever, if the adjusted basis of the property at the later foreclosed on or repossessed, gain or losstion rule does not apply if a charitable contribu- time of the change was more than its fair market is figured as discussed later. The abandonmenttion deduction is not allowable. value, the loss you can deduct is limited. loss is deducted in the tax year in which the loss

is sustained.Figure the loss you can deduct as follows.See Publication 526, Charitable Contribu-You cannot deduct any loss from abandon-tions, for information on figuring your charitable

1. Use the lesser of the property’s adjusted ment of your home or other property held forcontribution.basis or fair market value at the time of the personal use.change.Example. You sold property with a fair mar-

Example. Ann abandoned her home thatket value of $10,000 to a charitable organization 2. Add to (1) the cost of any improvementsshe bought for $200,000. At the time she aban-for $2,000 and are allowed a deduction for your and other increases to basis since thedoned the house, her mortgage balance wascontribution. Your adjusted basis in the property change.$185,000. She has a nondeductible loss ofis $4,000. Your gain on the sale is $1,200, fig-

3. Subtract from (2) depreciation and any $200,000 (the adjusted basis). If the bank laterured as follows.other decreases to basis since the change. forecloses on the loan or repossesses the

house, she will have to figure her gain or loss asSales price . . . . . . . . . . . . . . . . . . $2,000 4. Subtract the amount you realized on theMinus: Adjusted basis of part sold discussed later under Foreclosures and Repos-sale from the result in (3). If the amount($4,000 × ($2,000 ÷ $10,000)) . . . . . 800 sessions.you realized is more than the result in (3),Gain on the sale . . . . . . . . . . . . . . $1,200

treat this result as zero. Cancellation of debt. If the abandoned prop-erty secures a debt for which you are personallyThe result in (4) is the loss you can deduct.liable and the debt is canceled, you will realize

Property Used Partly ordinary income equal to the canceled debt.Example. You changed your main home tofor Business or Rental This income is separate from any loss realizedrental property 5 years ago. At the time of thefrom abandonment of the property. Report in-change, the adjusted basis of your home wasIf you sell or exchange property you used partly come from cancellation of a debt related to a$75,000 and the fair market value was $70,000.for business or rental purposes and partly for business or rental activity as business or rentalThis year, you sold the property for $55,000.personal purposes, you must figure the gain or income. Report income from cancellation of aYou made no improvements to the property butloss on the sale or exchange as though you had nonbusiness debt as other income on Formyou have depreciation expense of $12,620 oversold two separate pieces of property. You must 1040, line 21.the 5 prior years. Although your loss on the saleallocate the selling price, selling expenses, and However, income from cancellation of debt isis $7,380 [($75,000 − $12,620) − $55,000], thethe basis of the property between the business not taxed if any of the following conditions apply.amount you can deduct as a loss is limited toor rental part and the personal part. You must

$2,380, figured as follows. • The cancellation is intended as a gift.subtract depreciation you took or could havetaken from the basis of the business or rental • The debt is qualified farm debt (see chap-Lesser of adjusted basis or fairpart. ter 3 of Publication 225, Farmer’s Taxmarket value at time of the change $70,000Gain or loss on the business or rental part of Guide).Plus: Cost of any improvements andthe property may be a capital gain or loss or an any other additions to basis after • The debt is qualified real property busi-ordinary gain or loss, as discussed in chapter 3 the change . . . . . . . . . . . . . . . -0- ness debt (see chapter 5 of Publicationunder Section 1231 Gains and Losses. Any gain 70,000 334, Tax Guide for Small Business).on the personal part of the property is a capital Minus: Depreciation and any othergain. You cannot deduct a loss on the personal decreases to basis after the • You are insolvent or bankrupt (see Publi-part. change . . . . . . . . . . . . . . . . . . 12,620 cation 908).

57,380Example. You sold a condominium for

Forms 1099-A and 1099-C. If your aban-$57,000. You had bought the property 9 years Minus: Amount you realized from thedoned property secures a loan and the lendersale . . . . . . . . . . . . . . . . . . . . 55,000earlier in January for $30,000. You usedknows the property has been abandoned, theDeductible loss . . . . . . . . . . . . . . $2,380two-thirds of it as your home and rented out thelender should send you Form 1099-A showingother third. You claimed depreciation of $3,272information you need to figure your loss from thefor the rented part during the time you owned the Gain. If you have a gain on the sale, you gen- abandonment. However, if your debt is canceledproperty. You made no improvements to the erally must recognize the full amount of the gain. and the lender must file Form 1099-C, the lenderproperty. Your selling expenses for the condo- You figure the gain by subtracting your adjusted may include the information about the abandon-minium were $3,600. You figure your gain or basis from your amount realized, as described ment on that form instead of on Form 1099-A.loss as follows. earlier. The lender must file Form 1099-C and send you

You may be able to exclude all or part of the a copy if the amount of debt canceled is $600 orRental Personalgain if you owned and lived in the property as more and the lender is a financial institution,(1/3) (2/3)your main home for at least 2 years during the credit union, federal government agency, or any5-year period ending on the date of sale. For1) Selling price . . . . . . . . $19,000 $38,000 organization that has a significant trade or busi-more information, see Publication 523.2) Minus: Selling expenses 1,200 2,400 ness of lending money. For abandonments of

3) Amount realized property and debt cancellations occurring in(adjusted sales price) . . 17,800 35,600 2004, these forms should be sent to you by

4) Basis . . . . . . . . . . . . . 10,000 20,000 January 31, 2005.5) Minus: Depreciation . . . 3,272 Abandonments6) Adjusted basis . . . . . . . 6,728 20,0007) Gain (line 3 − line 6) . . . $11,072 $15,600 The abandonment of property is a disposition of

property. You abandon property when you vol- Foreclosuresuntarily and permanently give up possessionand use of the property with the intention of and RepossessionsProperty Changed toending your ownership but without passing it onBusiness or Rental Useto anyone else. If you do not make payments you owe on a loan

You cannot deduct a loss on the sale of property Loss from abandonment of business or in- secured by property, the lender may forecloseyou acquired for use as your home and used as vestment property is deductible as an ordinary on the loan or repossess the property. The fore-your home until the time of sale. loss, even if the property is a capital asset. The closure or repossession is treated as a sale or

You can deduct a loss on the sale of property loss is the property’s adjusted basis when aban- exchange from which you may realize gain oryou acquired for use as your home but changed doned. This rule also applies to leasehold im- loss. This is true even if you voluntarily return theto business or rental property and used as busi- provements the lessor made for the lessee that property to the lender. You also may realizeness or rental property at the time of sale. How- were abandoned. However, if the property is ordinary income from cancellation of debt if the




Seller’s (lender’s) gain or loss on reposses-Table 1-2. Worksheet for Foreclosures and Repossessionssion. If you finance a buyer’s purchase of(Keep for your records)property and later acquire an interest in itthrough foreclosure or repossession, you mayPart 1. Figure your income from cancellation of debt. (Note: If you are

not personally liable for the debt, you do not have income have a gain or loss on the acquisition. For morefrom cancellation of debt. Skip Part 1 and go to Part 2.) information, see Repossession in Publication

537.1. Enter the amount of debt canceled by the transfer of property . . . . . . . . . . .2. Enter the fair market value of the transferred property . . . . . . . . . . . . . . . . Cancellation of debt. If property that is repos-3. Income from cancellation of debt.* Subtract line 2 from line 1. If sessed or foreclosed on secures a debt for

less than zero, enter zero . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . which you are personally liable (recourse debt),you generally must report as ordinary incomePart 2. Figure your gain or loss from foreclosure or repossession.the amount by which the canceled debt is more

4. Enter the smaller of line 1 or line 2. Also include any proceeds you than the fair market value of the property. This received from the foreclosure sale. (If you are not personally liable income is separate from any gain or loss real- for the debt, enter the amount of debt canceled by the transfer of ized from the foreclosure or repossession. Re- property.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

port the income from cancellation of a debt5. Enter the adjusted basis of the transferred property . . . . . . . . . . . . . . . . . .related to a business or rental activity as busi-6. Gain or loss from foreclosure or repossession. Subtract line 5ness or rental income. Report the income from from line 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .cancellation of a nonbusiness debt as other in-come on Form 1040, line 21.

* The income may not be taxable. See Cancellation of debt.You can use Table 1-2 to figure yourincome from cancellation of debt.

loan balance is more than the fair market value $170,000, and Abena’s adjusted basis wasTIP

of the property. $175,000 due to a casualty loss she had de-ducted. The amount Abena realized on the fore- However, income from cancellation of debt is

Buyer’s (borrower’s) gain or loss. You fig- closure is $180,000, the debt canceled by the not taxed if any of the following conditions apply.ure and report gain or loss from a foreclosure or foreclosure. She figures her gain or loss by com- • The cancellation is intended as a gift.repossession in the same way as gain or loss paring the amount realized ($180,000) with herfrom a sale or exchange. The gain or loss is the adjusted basis ($175,000). She has a $5,000 • The debt is qualified farm debt (see chap-difference between your adjusted basis in the ter 3 of Publication 225, Farmer’s Taxrealized gain.transferred property and the amount realized. Guide).

Amount realized on a recourse debt. IfSee Gain or Loss From Sales and Exchanges, • The debt is qualified real property busi-you are personally liable for the debt (recourseearlier.ness debt (see chapter 5 of Publicationdebt), the amount realized on the foreclosure or

You can use Table 1-2 to figure your 334, Tax Guide for Small Business).repossession does not include the canceledgain or loss from a foreclosure or re- debt that is your income from cancellation of • You are insolvent or bankrupt (see Publi-possession.

TIP

debt. However, if the fair market value of the cation 908).transferred property is less than the canceledAmount realized on a nonrecourse debt.debt, the amount realized includes the canceledIf you are not personally liable for repaying the Forms 1099-A and 1099-C. A lender who ac-debt up to the fair market value of the property.debt (nonrecourse debt) secured by the trans- quires an interest in your property in a foreclo-You are treated as receiving ordinary incomeferred property, the amount you realize includes sure or repossession should send you Formfrom the canceled debt for the part of the debtthe full debt canceled by the transfer. The full 1099-A showing the information you need tothat is more than the fair market value. Seecanceled debt is included even if the fair market figure your gain or loss. However, if the lenderCancellation of debt, later.value of the property is less than the canceled also cancels part of your debt and must file Form

debt. 1099-C, the lender may include the informationExample 1. Assume the same facts as in about the foreclosure or repossession on that

the previous Example 1, except Chris is person-Example 1. Chris bought a new car for form instead of on Form 1099-A. The lenderally liable for the car loan (recourse debt). In this$15,000. He paid $2,000 down and borrowed must file Form 1099-C and send you a copy ifcase, the amount he realizes is $9,000. This isthe remaining $13,000 from the dealer’s credit the amount of debt canceled is $600 or morethe canceled debt ($10,000) up to the car’s faircompany. Chris is not personally liable for the and the lender is a financial institution, credit

loan (nonrecourse), but pledges the new car as market value ($9,000). Chris figures his gain or union, federal government agency, or any or-security. The credit company repossessed the ganization that has a significant trade or busi-loss on the repossession by comparing thecar because he stopped making loan payments. ness of lending money. For foreclosures oramount realized ($9,000) with his adjusted basisThe balance due after taking into account the repossessions occurring in 2004, these forms($15,000). He has a $6,000 nondeductible loss.payments Chris made was $10,000. The fair should be sent to you by January 31, 2005.He also is treated as receiving ordinary incomemarket value of the car when repossessed was from cancellation of debt. That income is $1,000$9,000. The amount Chris realized on the repos- ($10,000 - $9,000). This is the part of the can-session is $10,000. That is the debt canceled by celed debt not included in the amount realized.the repossession, even though the car’s fair Involuntarymarket value is less than $10,000. Chris figures Example 2. Assume the same facts as in Conversionshis gain or loss on the repossession by compar- the previous Example 2, except Abena is per-ing the amount realized ($10,000) with his ad- sonally liable for the loan (recourse debt). In this

An involuntary conversion occurs when yourjusted basis ($15,000). He has a $5,000 case, the amount she realizes is $170,000. Thisproperty is destroyed, stolen, condemned, ornondeductible loss. is the canceled debt ($180,000) up to the fair disposed of under the threat of condemnation

market value of the house ($170,000). AbenaExample 2. Abena paid $200,000 for her and you receive other property or money infigures her gain or loss on the foreclosure byhome. She paid $15,000 down and borrowed payment, such as insurance or a condemnationcomparing the amount realized ($170,000) withthe remaining $185,000 from a bank. Abena is award. Involuntary conversions are also calledher adjusted basis ($175,000). She has anot personally liable for the loan (nonrecourse involuntary exchanges.$5,000 nondeductible loss. She also is treateddebt), but pledges the house as security. The Gain or loss from an involuntary conversionas receiving ordinary income from cancellationbank foreclosed on the loan because Abena of your property is usually recognized for taxof debt. That income is $10,000 ($180,000 -stopped making payments. When the bank fore- purposes unless the property is your main$170,000). This is the part of the canceled debtclosed on the loan, the balance due was home. You report the gain or deduct the loss on

$180,000, the fair market value of the house was not included in the amount realized. your tax return for the year you realize it. (You




Table 1-3. Worksheet for Condemnations(Keep for your records)

Part 1. Gain from severance damages.(If you did not receive severance damages, skip Part 1 and go to Part 2.)

1. Enter severance damages received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2. Enter your expenses in getting severance damages3. Subtract line 2 from line 1. If less than zero, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4. Enter any special assessment on remaining property taken out of your award . . . . . . . . . . . . . . . . . . . . . . . . .5. Net severance damages. Subtract line 4 from line 3. If less than zero, enter -0- . . . . . . . . . . . . . . . . . . . . . . . .6. Enter the adjusted basis of the remaining property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7. Gain from severance damages. Subtract line 6 from line 5. If less than zero, enter -0- . . . . . . . . . . . . . . . . . . . .8. Refigured adjusted basis of the remaining property. Subtract line 5 from line 6. If less than zero, enter -0-

Part 2. Gain or loss from condemnation award.

9. Enter the condemnation award received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10. Enter your expenses in getting the condemnation award . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11. If you completed Part 1, and line 4 is more than line 3, subtract line 3 from line 4. Otherwise, enter -0- . . . . . . . .12. Add lines 10 and 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13. Net condemnation award. Subtract line 12 from line 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14. Enter the adjusted basis of the condemned property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15. Gain from condemnation award. If line 14 is more than line 13, enter -0-. Otherwise, subtract line 14 from

line 13 and skip line 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16. Loss from condemnation award. Subtract line 13 from line 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(Note: You cannot deduct the amount on line 16 if the condemned property was held for personal use.)

Part 3. Postponed gain from condemnation.(Complete only if line 7 or line 15 is more than zero and you bought qualifying replacement property or madeexpenditures to restore the usefulness of your remaining property.)

17. If you completed Part 1, and line 7 is more than zero, enter the amount from line 5. Otherwise, enter -0- . . . . . . .18. If line 15 is more than zero, enter the amount from line 13. Otherwise, enter -0- . . . . . . . . . . . . . . . . . . . . . . . .19. Add lines 17 and 18* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20. Enter the total cost of replacement property and any expenses to restore the usefulness of your remaining

property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21. Subtract line 20 from line 19. If less than zero, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22. If you completed Part 1, add lines 7 and 15. Otherwise, enter the amount from line 15 . . . . . . . . . . . . . . . . . . .23. Recognized gain. Enter the smaller of line 21 or line 22. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24. Postponed gain. Subtract line 23 from line 22. If less than zero, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . .

*If the condemned property was your main home, subtract from this total the gain you excluded from your income and enter the result.

cannot deduct a loss from an involuntary con- that has the power to legally take it. The owner thority, this sale also qualifies as an involuntaryversion of property you held for personal use receives a condemnation award (money or conversion.unless the loss resulted from a casualty or theft.) property) in exchange for the property taken. A Reports of condemnation. A threat of con-

condemnation is like a forced sale, the ownerHowever, depending on the type of property demnation exists if you learn of a decision tobeing the seller and the condemning authorityyou receive, you may not have to report a gain acquire your property for public use through abeing the buyer.on an involuntary conversion. You do not report report in a newspaper or other news medium,the gain if you receive property that is similar or and this report is confirmed by a representativeExample. A local government authorized torelated in service or use to the converted prop- of the government body or public official in-acquire land for public parks informed you that iterty. Your basis for the new property is the same volved. You must have reasonable grounds towished to acquire your property. After the localas your basis for the converted property. This believe that they will take necessary steps togovernment took action to condemn your prop-means that the gain is deferred until a taxable condemn your property if you do not sell volunta-erty, you went to court to keep it. But, the courtsale or exchange occurs. rily. If you relied on oral statements made by adecided in favor of the local government, whichIf you receive money or property that is not government representative or public official, thetook your property and paid you an amount fixedsimilar or related in service or use to the involun- Internal Revenue Service may ask you to getby the court. This is a condemnation of privatetarily converted property and you buy qualifying written confirmation of the statements.property for public use.replacement property within a certain period oftime, you can choose to postpone reporting the Example. Your property lies along publicThreat of condemnation. A threat of con-gain. utility lines. The utility company has the authoritydemnation exists if a representative of a govern-

to condemn your property. The company in-This publication explains the treatment of a ment body or a public official authorized toforms you that it intends to acquire your propertygain or loss from a condemnation or disposition acquire property for public use informs you thatby negotiation or condemnation. A threat of con-under the threat of condemnation. If you have a the government body or official has decided todemnation exists when you receive the notice.gain or loss from the destruction or theft of prop- acquire your property. You must have reasona-

erty, see Publication 547. ble grounds to believe that, if you do not sellRelated property voluntarily sold. A volun-voluntarily, your property will be condemned.tary sale of your property may be treated as aThe sale of your property to someone otherCondemnationsforced sale that qualifies as an involuntary con-than the condemning authority will also qualifyversion if the property had a substantial eco-A condemnation is the process by which private as an involuntary conversion, provided you havenomic relationship to property of yours that wasproperty is legally taken for public use without reasonable grounds to believe that your prop-condemned. A substantial economic relation-the owner’s consent. The property may be taken erty will be condemned. If the buyer of this prop-ship exists if together the properties were oneby the federal government, a state government, erty knows at the time of purchase that it will beeconomic unit. You also must show that thea political subdivision, or a private organization condemned and sells it to the condemning au-




condemned property could not reasonably or ness, or farm as a result of federal or federally Net severance damages. To figure youradequately be replaced. You can choose to assisted programs are not part of the condem- net severance damages, you first must reducepostpone reporting the gain by buying replace- nation award. Do not include them in your in- your severance damages by your expenses inment property. See Postponement of Gain, come. Replacement housing payments used to obtaining the damages. You then reduce themlater. buy new property are included in the property’s by any special assessment (described later) lev-

basis as part of your cost. ied against the remaining part of the propertyand taken out of the award by the condemningNet condemnation award. A net condem-Gain or Loss authority. The balance is your net severancenation award is the total award you received, orFrom Condemnations damages.are considered to have received, for the con-

demned property minus your expenses of ob-If your property was condemned or disposed of Expenses of obtaining a condemnationtaining the award. If only a part of your propertyunder the threat of condemnation, figure your award and severance damages. Subtractwas condemned, you also must reduce thegain or loss by comparing the adjusted basis of the expenses of obtaining a condemnationaward by any special assessment levied againstyour condemned property with your net con- award, such as legal, engineering, and appraisalthe part of the property you retain. This is dis-demnation award. fees, from the total award. Also, subtract thecussed later under Special assessment takenIf your net condemnation award is more than expenses of obtaining severance damages, thatout of award.the adjusted basis of the condemned property, may include similar expenses, from the sever-

you have a gain. You can postpone reporting ance damages paid to you. If you cannot deter-Severance damages. Severance damagesgain from a condemnation if you buy replace- mine which part of your expenses is for eachare not part of the award paid for the propertyment property. If only part of your property is part of the condemnation proceeds, you mustcondemned. They are paid to you if part of yourcondemned, you can treat the cost of restoring make a proportionate allocation.property is condemned and the value of the partthe remaining part to its former usefulness asyou keep is decreased because of the condem- Example. You receive a condemnationthe cost of replacement property. See Post-nation. award and severance damages. One-fourth ofponement of Gain, later.

For example, you may receive severance the total was designated as severance damagesIf your net condemnation award is less thandamages if your property is subject to flooding in your agreement with the condemning author-your adjusted basis, you have a loss. If your lossbecause you sell flowage easement rights (the ity. You had legal expenses for the entire con-is from property you held for personal use, youcondemned property) under threat of condem- demnation proceeding. You cannot determinecannot deduct it. You must report any deductiblenation. Severance damages also may be given how much of your legal expenses is for eachloss in the tax year it happened.to you if, because part of your property is con- part of the condemnation proceeds. You must

You can use Part 2 of Table 1-3 to demned for a highway, you must replace fences, allocate one-fourth of your legal expenses to thefigure your gain or loss from a condem- dig new wells or ditches, or plant trees to restore severance damages and the other three-fourthsnation award.

TIPyour remaining property to the same usefulness to the condemnation award.it had before the condemnation.

Special assessment taken out of award.Main home condemned. If you have a gain The contracting parties should agree on theWhen only part of your property is condemned, abecause your main home is condemned, you specific amount of severance damages in writ-special assessment levied against the remain-generally can exclude the gain from your income ing. If this is not done, all proceeds from theing property may be taken out of your condem-as if you had sold or exchanged your home. You condemning authority are considered awardednation award. An assessment may be levied ifmay be able to exclude up to $250,000 of the for your condemned property.the remaining part of your property benefited bygain (up to $500,000 if married filing jointly). For You cannot make a completely new alloca-the improvement resulting from the condemna-information on this exclusion, see Publication tion of the total award after the transaction istion. Examples of improvements that may cause523. If your gain is more than you can exclude completed. However, you can show how mucha special assessment are widening a street andbut you buy replacement property, you may be of the award both parties intended for severanceinstalling a sewer.able to postpone reporting the rest of the gain. damages. The severance damages part of the

To figure your net condemnation award, youSee Postponement of Gain, later. award is determined from all the facts and cir-generally reduce the award by the assessmentcumstances.

Condemnation award. A condemnation taken out of the award.award is the money you are paid or the value of Example. You sold part of your property to

Example. To widen the street in front ofother property you receive for your condemned the state under threat of condemnation. Theyour home, the city condemned a 25-foot deepproperty. The award is also the amount you are contract you and the condemning authoritystrip of your land. You were awarded $5,000 forpaid for the sale of your property under threat of signed showed only the total purchase price. Itthis and spent $300 to get the award. Beforecondemnation. did not specify a fixed sum for severance dam-paying the award, the city levied a special as-ages. However, at settlement, the condemningPayment of your debts. Amounts taken sessment of $700 for the street improvementauthority gave you closing papers showingout of the award to pay your debts are consid- against your remaining property. The city thenclearly the part of the purchase price that was forered paid to you. Amounts the government pays paid you only $4,300. Your net award is $4,000severance damages. You may treat this part asdirectly to the holder of a mortgage or lien ($5,000 total award minus $300 expenses inseverance damages.against your property are part of your award, obtaining the award and $700 for the special

even if the debt attaches to the property and is Treatment of severance damages. Your assessment taken out).not your personal liability. net severance damages are treated as the If the $700 special assessment were not

amount realized from an involuntary conversion taken out of the award and you were paidExample. The state condemned your prop- of the remaining part of your property. Use them $5,000, your net award would be $4,700 ($5,000erty for public use. The award was set at to reduce the basis of the remaining property. If − $300). The net award would not change, even$200,000. The state paid you only $148,000 the amount of severance damages is based on if you later paid the assessment from the amountbecause it paid $50,000 to your mortgage holder damage to a specific part of the property you you received.and $2,000 accrued real estate taxes. You are kept, reduce the basis of only that part by the netconsidered to have received the entire $200,000 Severance damages received. If sever-severance damages.as a condemnation award. ance damages are included in the condemna-If your net severance damages are more

tion proceeds, the special assessment taken outthan the basis of your retained property, youInterest on award. If the condemning au-is first used to reduce the severance damages.have a gain. You may be able to postpone re-thority pays you interest for its delay in payingAny balance of the special assessment is usedporting the gain. See Postponement of Gain,your award, it is not part of the condemnationto reduce the condemnation award.later.award. You must report the interest separately

as ordinary income. You can use Part 1 of Table 1-3 to Example. You were awarded $4,000 for thefigure any gain from severance dam-Payments to relocate. Payments you re- condemnation of your property and $1,000 forages and to refigure the adjusted basisceive to relocate and replace housing because severance damages. You spent $300 to obtain

TIP

of the remaining part of your property.you have been displaced from your home, busi- the severance damages. A special assessment




of $800 was taken out of the award. The $1,000 much as the amount realized for the condemned ing whether the total gain is more thanseverance damages are reduced to zero by first property. If the cost of the replacement property $100,000. If the property is owned by a partner-subtracting the $300 expenses and then $700 of is less than the amount realized, you must report ship, the $100,000 limit applies to the partner-the special assessment. Your $4,000 condem- the gain up to the unspent part of the amount ship and each partner. If the property is ownednation award is reduced by the $100 balance of realized. by an S corporation, the $100,000 limit appliesthe special assessment, leaving a $3,900 net The basis of the replacement property is its to the S corporation and each shareholder.condemnation award. cost, reduced by the postponed gain. Also, if Exception. This rule does not apply if the

your replacement property is stock in a corpora- related person acquired the property from anPart business or rental. If you used part of tion that owns property similar or related in serv- unrelated person within the replacement period.your condemned property as your home and ice or use, the corporation generally will reducepart as business or rental property, treat each its basis in its assets by the amount by which Advance payment. If you pay a contractor inpart as a separate property. Figure your gain or you reduce your basis in the stock. See Control- advance to build your replacement property, youloss separately because gain or loss on each ling interest in a corporation, later. have not bought replacement property unless itpart may be treated differently.

is finished before the end of the replacementYou can use Part 3 of Table 1-3 toSome examples of this type of property are aperiod (discussed later).figure the gain you must report andbuilding in which you live and operate a grocery,

your postponed gain.TIP

and a building in which you live on the first floor Replacement property. To postpone report-and rent out the second floor.

ing gain, you must buy replacement property forPostponing gain on severance damages. Ifthe specific purpose of replacing your con-you received severance damages for part ofExample. You sold your building fordemned property. You do not have to use theyour property because another part was con-$24,000 under threat of condemnation to a pub-actual funds from the condemnation award todemned and you buy replacement property, youlic utility company that had the authority to con-acquire the replacement property. Property youcan choose to postpone reporting gain. Seedemn. You rented half the building and lived inacquire by gift or inheritance does not qualify asTreatment of severance damages, earlier. Youthe other half. You paid $25,000 for the buildingreplacement property.can postpone reporting all your gain if the re-and spent an additional $1,000 for a new roof.

placement property costs at least as much asYou claimed allowable depreciation of $4,600 Similar or related in service or use. Youryour net severance damages plus your net con-on the rental half. You spent $200 in legal ex- replacement property must be similar or relateddemnation award (if resulting in gain).penses to obtain the condemnation award. Fig- in service or use to the property it replaces.

You also can make this choice if you spendure your gain or loss as follows. If the condemned property is real propertythe severance damages, together with other you held for use in your trade or business or formoney you received for the condemned prop-Resi- Busi- investment (other than property held mainly for

dential ness erty (if resulting in gain), to acquire nearby prop- sale), but your replacement property is not simi-Part Part erty that will allow you to continue your business. lar or related in service or use, it will be treated

1) Condemnation award If suitable nearby property is not available and as such if it is like-kind property to be held forreceived . . . . . . . . . . $12,000 $12,000 you are forced to sell the remaining property and use in a trade or business or for investment. For2) Minus: Legal expenses, relocate in order to continue your business, see a discussion of like-kind property, see Like-Kind$200 . . . . . . . . . . . . 100 100 Postponing gain on the sale of related property, Property under Like-Kind Exchanges, later.3) Net condemnation next.award . . . . . . . . . . . . $11,900 $11,900 Owner-user. If you are an owner-user, simi-If you restore the remaining property to its

4) Adjusted basis: lar or related in service or use means that re-former usefulness, you can treat the cost of1/2 of original cost, placement property must function in the samerestoring it as the cost of replacement property.$25,000 Plus: 1/2 of way as the property it replaces.cost of roof, $12,500 $12,500 Postponing gain on the sale of related prop-$1,000 . . . . . . . . . 500 500 erty. If you sell property that is related to the Example. Your home was condemned and

Total . . . . . . . . . $13,000 $13,000 condemned property and then buy replacement you invested the proceeds from the condemna-5) Minus: Depreciation . . 4,600 property, you can choose to postpone reporting tion in a grocery store. Your replacement prop-6) Adjusted basis, gain on the sale. You must meet the require- erty is not similar or related in service or use tobusiness part $8,400 ments explained earlier under Related property the condemned property. To be similar or re-7) (Loss) on residential ($1,100) voluntarily sold. You can postpone reporting all lated in service or use, your replacement prop-property . . . . . . . . .your gain if the replacement property costs at erty must also be used by you as your home.8) Gain on business property . . . . $3,500least as much as the amount realized from the

Owner-investor. If you are an owner-inves-The loss on the residential part of the property sale plus your net condemnation award (if re-tor, similar or related in service or use meansis not deductible. sulting in gain) plus your net severance dam-that any replacement property must have theages, if any (if resulting in gain).same relationship of services or uses to you as

Buying replacement property from a related the property it replaces. You decide this by de-Postponement of Gain person. Certain taxpayers cannot postpone termining all the following information.reporting gain from a condemnation if they buyDo not report the gain on condemned property if • Whether the properties are of similar serv-the replacement property from a related person.you receive only property that is similar or re- ice to you.For information on related persons, see Nonde-lated in service or use to the condemned prop-ductible Loss under Sales and Exchanges Be- • The nature of the business risks con-erty. Your basis for the new property is the sametween Related Persons in chapter 2. nected with the properties.as your basis for the old.

This rule applies to the following taxpayers.• What the properties demand of you in theMoney or unlike property received. You or-

1. C corporations. way of management, service, and rela-dinarily must report the gain if you receivetions to your tenants.money or unlike property. You can choose to 2. Partnerships in which more than 50% of

postpone reporting the gain if you buy property the capital or profits interest is owned by Cthat is similar or related in service or use to the Example. You owned land and a buildingcorporations.condemned property within the replacement pe- you rented to a manufacturing company. The

3. All others (including individuals, partner-riod, discussed later. You also can choose to building was condemned. During the replace-ships (other than those in (2)), and S cor-postpone reporting the gain if you buy a control- ment period, you had a new building built onporations) if the total realized gain for theling interest (at least 80%) in a corporation ownother land you already owned. You rented outtax year on all involuntarily converteding property that is similar or related in service or the new building for use as a wholesale groceryproperties on which there are realizeduse to the condemned property. See Controlling warehouse. The replacement property is alsogains is more than $100,000.interest in a corporation, later. rental property, so the two properties are consid-

To postpone reporting all the gain, you must For taxpayers described in (3) above, gains ered similar or related in service or use if there isbuy replacement property costing at least as cannot be offset with any losses when determin- a similarity in all the following areas.




If two or more properties fall in the same class, For accrual basis taxpayers, gain (if any)• Your management activities.allocate the reduction to each property in pro- accrues in the earlier year when either of the

• The amount and kind of services you proportion to the adjusted bases of all the properties following occurs.vide to your tenants. in that class. The reduced basis of any single • All events have occurred that fix the rightproperty cannot be less than zero.• The nature of your business risks con- to the condemnation award and thenected with the properties. amount can be determined with reasona-Main home replaced. If your gain from a con-

ble accuracy.demnation of your main home is more than youLeasehold replaced with fee simple prop- can exclude from your income (see Main home • All or part of the award is actually or con-erty. Fee simple property you will use in your condemned under Gain or Loss From Condem- structively received.trade or business or for investment can qualify nations, earlier), you can postpone reporting the

as replacement property that is similar or related For example, if you have an absolute right to arest of the gain by buying replacement propertyin service or use to a condemned leasehold if part of a condemnation award when it is depos-that is similar or related in service or use. Toyou use it in the same business and for the ited with the court, the amount deposited ac-postpone reporting all the gain, the replacementidentical purpose as the condemned leasehold. crues in the year the deposit is made evenproperty must cost at least as much as the

though the full amount of the award is still con-A fee simple property interest generally is a amount realized from the condemnation minustested.property interest that entitles the owner to the the excluded gain.

entire property with unconditional power to dis- You must reduce the basis of your replace- Replacement property bought before thepose of it during his or her lifetime. A leasehold ment property by the postponed gain. Also, if condemnation. If you buy your replacementis property held under a lease, usually for a term you postpone reporting any part of your gain property after there is a threat of condemnationof years. under these rules, you are treated as having but before the actual condemnation and you still

owned and used the replacement property as hold the replacement property at the time of theOutdoor advertising display replaced withyour main home for the period you owned and condemnation, you have bought your replace-real property. You can choose to treat anused the condemned property as your main ment property within the replacement period.outdoor advertising display as real property. Ifhome. Property you acquire before there is a threat ofyou make this choice and you replace the dis-

condemnation does not qualify as replacementplay with real property in which you hold a differ-Replacement period. To postpone reporting property acquired within the replacement pe-ent kind of interest, your replacement propertyyour gain from a condemnation, you must buy riod.can qualify as like-kind property. For example,replacement property within a certain period ofreal property bought to replace a destroyed bill-time. This is the replacement period. Example. On April 3, 2003, city authoritiesboard and leased property on which the bill-

The replacement period for a condemnation notified you that your property would be con-board was located qualifies as property of a likebegins on the earlier of the following dates. demned. On June 5, 2003, you acquired prop-kind.

erty to replace the property to be condemned.• The date on which you disposed of theYou can make this choice only if you did notYou still had the new property when the city tookcondemned property.claim a section 179 deduction for the display.possession of your old property on September

You cannot cancel this choice unless you get the • The date on which the threat of condem- 4, 2004. You have made a replacement withinconsent of the Internal Revenue Service. nation began. the replacement period.

An outdoor advertising display is a sign orExtension. You can get an extension of thedevice rigidly assembled and permanently at- The replacement period ends 2 years after the

replacement period if you apply to the IRS direc-tached to the ground, a building, or any other end of the first tax year in which any part of thetor for your area. You should apply before thepermanent structure used to display a commer- gain on the condemnation is realized.end of the replacement period. Your applicationcial or other advertisement to the public. If real property held for use in a trade orshould contain all details of your need for anbusiness or for investment (not including prop-Substituting replacement property. Once extension. You can file an application within aerty held primarily for sale) is condemned, theyou designate certain property as replacement reasonable time after the replacement periodreplacement period ends 3 years after the end ofproperty on your tax return, you cannot substi- ends if you can show reasonable cause for thethe first tax year in which any part of the gain ontute other qualified property. But, if your previ- delay. An extension of the replacement periodthe condemnation is realized. However, thisously designated replacement property does not will be granted if you can show reasonable3-year replacement period cannot be used if youqualify, you can substitute qualified property if cause for not making the replacement within thereplace the condemned property by acquiringyou acquire it within the replacement period. regular period.control of a corporation owning property that is

Ordinarily, requests for extensions aresimilar or related in service or use.Controlling interest in a corporation. You granted near the end of the replacement periodcan replace property by acquiring a controlling New York Liberty Zone property con- or the extended replacement period. Extensionsinterest in a corporation that owns property simi- demned. If property in the New York Liberty are usually limited to a period of 1 year or less.lar or related in service or use to your con- Zone was condemned as a result of the Septem- The high market value or scarcity of replace-demned property. You have controlling interest ber 11, 2001, terrorist attacks, the replacement ment property is not a sufficient reason for grant-if you own stock having at least 80% of the period ends 5 years after the end of the first tax ing an extension. If your replacement property iscombined voting power of all classes of voting year in which any part of the gain on the con- being built and you clearly show that the re-stock and at least 80% of the total number of demnation is realized. This 5-year replacement placement or restoration cannot be made withinshares of all other classes of stock. period applies only if substantially all of the use the replacement period, you will be granted an

of the replacement property is in New York City. extension of the period.Basis adjustment to corporation’s prop-erty. The basis of property held by the corpo- Determining when gain is realized. If you

Choosing to postpone gain. Report yourration at the time you acquired control must be are a cash basis taxpayer, you realize gain whenchoice to postpone reporting your gain, alongreduced by your postponed gain, if any. You are you receive payments that are more than yourwith all necessary details, on a statement at-not required to reduce the adjusted bases of the basis in the property. If the condemning author-tached to your return for the tax year in whichcorporation’s properties below your adjusted ba- ity makes deposits with the court, you realizeyou realize the gain.sis in the corporation’s stock (determined after gain when you withdraw (or have the right to

If a partnership or a corporation owns thereduction by your postponed gain). withdraw) amounts that are more than your ba-condemned property, only the partnership orsis.Allocate this reduction to the following clas- corporation can choose to postpone reportingThis applies even if the amounts receivedses of property in the order shown below. the gain.are only partial or advance payments and the full

1. Property that is similar or related in service award has not yet been determined. A replace- Replacement property acquired after re-or use to the condemned property. ment will be too late if you wait for a final deter- turn filed. If you buy the replacement property

mination that does not take place in the after you file your return reporting your choice to2. Depreciable property not reduced in (1).applicable replacement period after you first re- postpone reporting the gain, attach a statement

3. All other property. alize gain. to your return for the year in which you buy the




property. The statement should contain detailed 4797. If you had a gain, you may have to report allowed $8,000 for the old cab and pays $22,000information on the replacement property. all or part of it as ordinary income. See Like-Kind cash. He has no recognized gain or loss on the

Exchanges and Involuntary Conversions in transaction regardless of the adjusted basis ofAmended return. If you choose to post-chapter 3. his old cab. If Bill sold the old cab to a third partypone reporting gain, you must file an amended

for $8,000 and bought a new one, he would havereturn for the year of the gain (individuals filea recognized gain or loss on the sale of his oldForm 1040X) in either of the following situations.cab equal to the difference between the amount

• You do not buy replacement property realized and the adjusted basis of the old cab.Nontaxable Exchangeswithin the replacement period. On your

Sale and purchase. If you sell property andamended return, you must report the gain Certain exchanges of property are not taxable.and pay any additional tax due. buy similar property in two mutually dependentThis means any gain from the exchange is not

transactions, you may have to treat the sale andrecognized, and any loss cannot be deducted.• The replacement property you buy costspurchase as a single nontaxable exchange.Your gain or loss will not be recognized until youless than the amount realized for the con-

sell or otherwise dispose of the property youdemned property (minus the gain you ex- Example. You used your car in your busi-receive.cluded from income if the property was ness for 2 years. Its adjusted basis is $3,500 andyour main home). On your amended re-

its trade-in value is $4,500. You are interested inturn, you must report the part of the gain Like-Kind Exchanges a new car that costs $20,000. Ordinarily, youyou cannot postpone reporting and pay

would trade your old car for the new one and payThe exchange of property for the same kind ofany additional tax due.the dealer $15,500. Your basis for depreciationproperty is the most common type of nontaxableof the new car would then be $19,000 ($15,500exchange. To be a like-kind exchange, the prop-Time for assessing a deficiency. Any defi-plus $3,500 adjusted basis of the old car).erty traded and the property received must beciency for any tax year in which part of the gain is

You want your new car to have a larger basisboth of the following.realized may be assessed at any time before thefor depreciation, so you arrange to sell your oldexpiration of 3 years from the date you notify the • Qualifying property. car to the dealer for $4,500. You then buy theIRS director for your area that you have re-new one for $20,000 from the same dealer.placed, or intend not to replace, the condemned • Like-kind property.However, you are treated as having exchangedproperty within the replacement period.

These two requirements are discussed later. your old car for the new one because the saleChanging your mind. You can change and purchase are reciprocal and mutually de-Additional requirements apply to exchanges

your mind about reporting or postponing the pendent. Your basis for depreciation for the newin which the property received is not receivedgain at any time before the end of the replace- car is $19,000, the same as if you traded the oldimmediately upon the transfer of the propertyment period. car.given up. See Deferred Exchange, later.

If the like-kind exchange involves the receiptExample. Your property was condemned Reporting the exchange. Report the ex-of money or unlike property or the assumption ofand you had a gain of $5,000. You reported the change of like-kind property, even though noyour liabilities, you may have to recognize gain.gain on your return for the year in which you gain or loss is recognized, on Form 8824. TheSee Partially Nontaxable Exchanges, later.realized it, and paid the tax due. You buy re- instructions for the form explain how to reportplacement property within the replacement pe- the details of the exchange.Multiple-party transactions. The like-kindriod. You used all but $1,000 of the amount If you have any recognized gain becauseexchange rules also apply to property ex-realized from the condemnation to buy the re- you received money or unlike property, report itchanges that involve three- and four-party trans-placement property. You now change your mind on Schedule D (Form 1040) or Form 4797,actions. Any part of these multiple-partyand want to postpone reporting the $4,000 of whichever applies. See chapter 4. You maytransactions can qualify as a like-kind exchangegain equal to the amount you spent for the re- have to report the recognized gain as ordinaryif it meets all the requirements described in thisplacement property. You should file a claim for income from depreciation recapture. Seesection.refund on Form 1040X. Explain on Form 1040X Like-Kind Exchanges and Involuntary Conver-that you previously reported the entire gain from Receipt of title from third party. If you sions in chapter 3.the condemnation, but you now want to report receive property in a like-kind exchange and theonly the part of the gain equal to the condemna- other party who transfers the property to you Exchange expenses. Exchange expensestion proceeds not spent for replacement prop- does not give you the title, but a third party does, are generally the closing costs you pay. Theyerty ($1,000). you still can treat this transaction as a like-kind include such items as brokerage commissions,

exchange if it meets all the requirements. attorney fees, and deed preparation fees. Sub-tract these expenses from the consideration re-Reporting a Condemnation Basis of property received. If you acquire ceived to figure the amount realized on theGain or Loss property in a like-kind exchange, the basis of exchange. Also, add them to the basis of the

that property is the same as the basis of the like-kind property received. If you receive cashGenerally, you report gain or loss from a con- property you transferred. or unlike property in addition to the like-kinddemnation on your return for the year you realize For the basis of property received in an ex- property and realize a gain on the exchange,the gain or loss. change that is only partially nontaxable, see subtract the expenses from the cash or fair mar-Partially Nontaxable Exchanges, later.Personal-use property. Report gain from a ket value of the unlike property. Then, use the

condemnation of property you held for personal net amount to figure the recognized gain. SeeExample. You exchanged real estate helduse (other than excluded gain from a condem- Partially Nontaxable Exchanges, later.

for investment with an adjusted basis of $25,000nation of your main home or postponed gain) onfor other real estate held for investment. The fairSchedule D (Form 1040).market value of both properties is $50,000. TheDo not report loss from a condemnation of Qualifying Propertybasis of your new property is the same as thepersonal-use property. But, if you received abasis of the old ($25,000). In a like-kind exchange, both the property youForm 1099-S, Proceeds From Real Estate

give up and the property you receive must beTransactions (for example, showing the pro-Money paid. If, in addition to giving up held by you for investment or for productive useceeds of a sale of real estate under threat oflike-kind property, you pay money in a like-kind in your trade or business. Machinery, buildings,condemnation), you must show the transactionexchange, you still have no recognized gain or land, trucks, and rental houses are examples ofon Schedule D even though the loss is not de-loss. The basis of the property received is the property that may qualify.ductible. Complete columns (a) through (e), andbasis of the property given up, increased by the The rules for like-kind exchanges do not ap-enter -0- in column (f).money paid. ply to exchanges of the following property.

Business property. Report gain (other than• Property you use for personal purposes,postponed gain) or loss from a condemnation of Example. Bill Smith trades an old cab for a

property you held for business or profit on Form new one. The new cab costs $30,000. He is such as your home and your family car.




• Stock in trade or other property held pri- Personal property. Depreciable tangible per- ever, are within the same Product Class and aremarily for sale, such as inventories, raw of a like class.sonal property can be either like kind or likematerials, and real estate held by dealers. class to qualify for nonrecognition treatment. Intangible personal property and nonde-

Like-class properties are depreciable tangible preciable personal property. If you ex-• Stocks, bonds, notes, or other securitiespersonal properties within the same General change intangible personal property oror evidences of indebtedness, such as ac-Asset Class or Product Class. Property classi- nondepreciable personal property for like-kindcounts receivable.fied in any General Asset Class may not be property, no gain or loss is recognized on the• Partnership interests. classified within a Product Class. exchange. (There are no like classes for these

properties.) Whether intangible personal prop-• Certificates of trust or beneficial interest. General Asset Classes. General Asseterty, such as a patent or copyright, is of a likeClasses describe the types of property fre-• Choses in action. kind to other intangible personal property gener-quently used in many businesses. They includeally depends on the nature or character of theHowever, you may have a nontaxable exchange the following property.rights involved. It also depends on the nature orunder other rules. See Other Nontaxable Ex-character of the underlying property to whichchanges, later. 1. Office furniture, fixtures, and equipmentthose rights relate.(asset class 00.11).An exchange of the assets of a business for

the assets of a similar business cannot be 2. Information systems, such as computers Example. The exchange of a copyright on atreated as an exchange of one property for an- and peripheral equipment (asset class novel for a copyright on a different novel canother property. Whether you engaged in a 00.12). qualify as a like-kind exchange. However, thelike-kind exchange depends on an analysis of exchange of a copyright on a novel for a copy-3. Data handling equipment except com-each asset involved in the exchange. However, right on a song is not a like-kind exchange.puters (asset class 00.13).see Multiple Property Exchanges, later.

Goodwill and going concern. The ex-4. Airplanes (airframes and engines), exceptchange of the goodwill or going concern value ofplanes used in commercial or contract car-a business for the goodwill or going concernLike-Kind Property rying of passengers or freight, and all heli-value of another business is not a like-kind ex-copters (airframes and engines) (assetThere must be an exchange of like-kind prop- change.class 00.21).erty. Like-kind properties are properties of the

Foreign personal property exchanges.same nature or character, even if they differ in 5. Automobiles and taxis (asset class 00.22).Personal property used predominantly in thegrade or quality. The exchange of real estate for

6. Buses (asset class 00.23). United States and personal property usedreal estate and the exchange of personal prop-predominantly outside the United States are noterty for similar personal property are exchanges 7. Light general purpose trucks (asset classlike-kind property under the like-kind exchangeof like-kind property. For example, the trade of 00.241).rules. If you exchange property used predomi-land improved with an apartment house for land

8. Heavy general purpose trucks (asset class nantly in the United States for property usedimproved with a store building, or a panel truck00.242). predominantly outside the United States, yourfor a pickup truck, is a like-kind exchange.

gain or loss on the exchange is recognized.An exchange of personal property for real 9. Railroad cars and locomotives exceptproperty does not qualify as a like-kind ex- those owned by railroad transportation Predominant use. You determine the pre-change. For example, an exchange of a piece of companies (asset class 00.25). dominant use of property you gave up based onmachinery for a store building does not qualify. where that property was used during the 2-year10. Tractor units for use over the road (assetAlso, the exchange of livestock of different period ending on the date you gave it up. Youclass 00.26).sexes does not qualify. determine the predominant use of the property

11. Trailers and trailer-mounted containers you acquired based on where that property wasReal property. An exchange of city property (asset class 00.27). used during the 2-year period beginning on thefor farm property, or improved property for unim- date you acquired it.12. Vessels, barges, tugs, and similarproved property, is a like-kind exchange.

But if you held either property less than 2water-transportation equipment, exceptThe exchange of real estate you own for ayears, determine its predominant use based onthose used in marine construction (assetreal estate lease that runs 30 years or longer is awhere that property was used only during theclass 00.28).like-kind exchange. However, not all exchangesperiod of time you (or a related person) held it.of interests in real property qualify. The ex- 13. Industrial steam and electric generation or This does not apply if the exchange is part of achange of a life estate expected to last less than distribution systems (asset class 00.4). transaction (or series of transactions) structured30 years for a remainder interest is not ato avoid having to treat property as unlike prop-like-kind exchange. Product Classes. Product Classes include erty under this rule.An exchange of a remainder interest in real property listed in a 6-digit product class (except However, you must treat property as usedestate for a remainder interest in other real es- any ending in 9) in sectors 31 through 33 of the predominantly in the United States if it is usedtate is a like-kind exchange if the nature or North American Industry Classification System outside the United States but, under sectioncharacter of the two property interests is the (NAICS) of the Executive Office of the Presi- 168(g)(4) of the Internal Revenue Code, is eligi-same. dent, Office of Management and Budget, United ble for accelerated depreciation as though used

States, 2002 (NAICS Manual). It can be ac-Foreign real property exchanges. Real in the United States.cessed at http://www.census.gov/naics. Copiesproperty located in the United States and realof the manual may be obtained from the Nationalproperty located outside the United States areTechnical Information Service by calling 1-800-not considered like-kind property under the Deferred Exchange

like-kind exchange rules. If you exchange for- 553-NTIS (1-800-553-6847). The cost of theA deferred exchange is one in which you trans-eign real property for property located in the manual is $49 (plus shipping and handling) andfer property you use in business or hold forUnited States, your gain or loss on the exchange the order number is PB2002101430.investment and later you receive like-kind prop-is recognized. Foreign real property is real prop-erty you will use in business or hold for invest-Example 1. You transfer a personal com-erty not located in a state or the District of Co-ment. (The property you receive is replacementputer used in your business for a printer to belumbia.property.) The transaction must be an exchangeused in your business. The properties ex-This foreign real property exchange rule(that is, property for property) rather than adoes not apply to the replacement of con- changed are within the same General Assettransfer of property for money used to buy re-demned real property. Foreign and U.S. real Class and are of a like class.placement property.property can still be considered like-kind prop-

Example 2. Trena transfers a grader to Ronerty under the rules for replacing condemned If, before you receive the replacement prop-in exchange for a scraper. Both are used in aproperty to postpone reporting gain on the con- erty, you actually or constructively receivebusiness. Neither property is within any of thedemnation. See Postponement of Gain under money or unlike property in full payment for theGeneral Asset Classes. Both properties, how-Involuntary Conversions, earlier. property you transfer, the transaction will be




treated as a sale rather than a deferred ex- riod, but only if the fair market value of the Like-Kind Exchangeschange. In that case, you must recognize gain or property is at least 95% of the total fair Using Qualified Intermediariesloss on the transaction, even if you later receive market value of all identified replacement

If you transfer property through a qualified inter-the replacement property. (It would be treated properties. (Do not include any you can-mediary, the transfer of the property given upas if you bought it.) celed.) Fair market value is determined onand receipt of like-kind property is treated as anYou constructively receive money or unlike the earlier of the date you received theexchange. This rule applies even if you receiveproperty when the money or property is credited property or the last day of the receipt pe-money or other property directly from a party toto your account or made available to you. You riod.the transaction other than the qualified interme-also constructively receive money or unlikediary.property when any limits or restrictions on it Disregard incidental property. Do not

A qualified intermediary is a person who en-expire or are waived. treat property incidental to a larger item of prop-ters into a written exchange agreement with youWhether you actually or constructively re- erty as separate from the larger item when youto acquire and transfer the property you give upceive money or unlike property, however, is de- identify replacement property. Property is inci-and to acquire the replacement property andtermined without regard to certain arrangements dental if it meets both the following tests.transfer it to you. This agreement must ex-you make to ensure that the other party carries

• It is typically transferred with the larger pressly limit your rights to receive, pledge, bor-out its obligation to transfer the replacementitem. row, or otherwise obtain the benefits of money orproperty to you. For example, if you have that

other property held by the qualified intermediary.obligation secured by a mortgage or by cash or • The total fair market value of all the inci-its equivalent held in a qualified escrow account dental property is not more than 15% of Multiple-party transactions involving relatedor qualified trust, that arrangement will be disre- the total fair market value of the larger persons. A taxpayer who transfers propertygarded in determining whether you actually or item of property. given up to a qualified intermediary in exchangeconstructively receive money or unlike property.

for replacement property formerly owned by aFor more in format ion, see sect ion Replacement property to be produced. related person is not entitled to nonrecognition1.1031(k)-1(g) of the regulations. Also, see Gain or loss from a deferred exchange can qual- treatment if the related person receives cash orLike-Kind Exchanges Using Qualified In- ify for nonrecognition even if the replacement unlike property for the replacement property.termediaries, later. property is not in existence or is being produced (See Like-Kind Exchanges Between Relatedat the time you identify it as replacement prop- Persons, later.)Identification requirement. You must identify erty. If you need to know the fair market value of A qualified intermediary cannot be either ofthe property to be received within 45 days after the replacement property to identify it, estimate the following.the date you transfer the property given up in the its fair market value as of the date you expect to

exchange. This period of time is called the iden- • Your agent at the time of the transaction.receive it.tification period. Any property received during This includes a person who has been yourthe identification period is considered to have employee, attorney, accountant, invest-Receipt requirement. The property must bebeen identified. ment banker or broker, or real estatereceived by the earlier of the following dates.

If you transfer more than one property (as agent or broker within the 2-year periodpart of the same transaction) and the properties before the transfer of property you give up.• The 180th day after the date on which youare transferred on different dates, the identifica- transfer the property given up in the ex- • A person who is related to you or yourtion period and the receipt period begin on the change. agent under the rules discussed in chapterdate of the earliest transfer.

2 under Nondeductible Loss, substituting• The due date, including extensions, forIdentifying replacement property. You “10%” for “50%.”your tax return for the tax year in which

must identify the replacement property in a the transfer of the property given up oc-signed written document and deliver it to the An intermediary is treated as acquiring andcurs.other person involved in the exchange. You transferring property if all the following require-

You must receive substantially the same prop-must clearly describe the replacement property ments are met.erty that met the identification requirement, dis-in the written document. For example, use the • The intermediary acquires and transferscussed earlier.legal description or street address for real prop-

legal title to the property.erty and the make, model, and year for a car. In Replacement property produced afterthe same manner, you can cancel an identifica- identification. In some cases, the replace- • The intermediary enters into an agreementtion of replacement property at any time before ment property may have been produced after with a person other than you for the trans-the end of the identification period. you identified it (as described earlier in Replace- fer to that person of the property you give

ment property to be produced.) In that case, to up and that property is transferred to thatIdentifying alternative and multiple proper-determine whether the property you received person.ties. You can identify more than one replace-was substantially the same property that met thement property. Regardless of the number of • The intermediary enters into an agreementidentification requirement, do not take into ac-properties you give up, the maximum number of with the owner of the replacement prop-count any variations due to usual productionreplacement properties you can identify is the erty for the transfer of that property andchanges. Substantial changes in the property tolarger of the following. the replacement property is transferred tobe produced, however, will disqualify it.

you.• Three. If your replacement property is personalproperty that had to be produced, it must be• Any number of properties whose total fair An intermediary is treated as entering into ancompleted by the date you receive it to qualify asmarket value (FMV) at the end of the iden- agreement if the rights of a party to the agree-substantially the same property you identified.tification period is not more than double ment are assigned to the intermediary and all

If your replacement property is real propertythe total fair market value, on the date of parties to that agreement are notified in writingthat had to be produced and it is not completedtransfer, of all properties you give up. of the assignment by the date of the relevantby the date you receive it, it still may qualify as transfer of property.substantially the same property you identified. ItIf, as of the end of the identification period,will qualify only if, had it been completed on time,you have identified more properties than permit-it would have been considered to be substan-ted under this rule, the only property that will be Like-Kind Exchanges Usingtially the same property you identified. It is con-considered identified is: Qualified Exchangesidered to be substantially the same only to the Accommodation Arrangements• Any replacement property you received extent it is considered real property under local (QEAAs)before the end of the identification period, law. However, any additional production on the

and replacement property after you receive it does The like-kind exchange rules generally do notnot qualify as like-kind property. (To this extent,• Any replacement property identified before apply to an exchange in which you acquire re-the transaction is treated as a taxable exchangethe end of the identification period and replacement property (new property) before youof property for services.)ceived before the end of the receipt pe- transfer relinquished property (property you give




up). However, if you use a qualified exchange requirement earlier under Deferred Ex- as a result of certain legal or contractual ar-accommodation arrangement (QEAA), the change. rangements, regardless of whether the arrange-transfer may qualify as a like-kind exchange. ments contain terms that typically would result2. One of the following transfers must take

from arm’s-length bargaining between unrelatedUnder a QEAA, either the replacement prop- place no later than 180 days after theparties for those arrangements. For a list oferty or the relinquished property is transferred to transfer of qualified indications of owner-those arrangements, see Revenue Procedurean exchange accommodation titleholder (EAT), ship of the property to the EAT.2000-37 in Internal Revenue Bulletin 2000-40.discussed later, who is treated as the beneficial

owner of the property. However, the replace- a. The replacement property is transferredment property held in a QEAA may not be to you (either directly or indirectly

Partially Nontaxable Exchangestreated as property received in an exchange if through a qualified intermediary, de-you previously owned it within 180 days of its fined earlier under Like-Kind Exchanges If, in addition to like-kind property, you receivetransfer to the EAT. If the property is held in a Using Qualified Intermediaries). money or unlike property in an exchange onQEAA, the IRS will accept the qualification of

which you realize a gain, you have a partiallyb. The relinquished property is transferredproperty as either replacement property or relin-nontaxable exchange. You are taxed on the gainto a person other than you or a disquali-quished property and the treatment of an EAT asyou realize, but only to the extent of the moneyfied person. A disqualified person is ei-the beneficial owner of the property for federaland the fair market value of the unlike propertyther of the following.income tax purposes.you receive.

i. Your agent at the time of the trans-Requirements for a QEAA. Property is held A loss is never deductible in a nontax-action. This includes a person whoin a QEAA only if all the following requirements able exchange in which you receivehas been your employee, attorney,are met. unlike property or cash.

TIPaccountant, investment banker orbroker, or real estate agent or bro-• You have a written agreement.ker within the 2-year period before Figuring taxable gain. To figure the taxable• The time limits for identifying and transfer- the transfer of the relinquished prop- gain, first determine the fair market value of any

ring the property are met. erty. unlike property you receive and add it to anymoney you receive. Reduce that total by any• The qualified indications of ownership of ii. A person who is related to you orexchange expenses (closing costs) you paid.property are transferred to an EAT. your agent under the rules dis-The result is the maximum gain that can becussed in chapter 2 under Nonde-taxed. Next, figure the gain on the whole ex-ductible Loss, substituting “10%” forWritten agreement. Under a QEAA, you and change as discussed earlier under Gain or Loss“50%.”the EAT must enter into a written agreement no From Sales and Exchanges. Your recognized

later than 5 business days after the qualified (taxable) gain is the lesser of these twoindications of ownership (discussed later) are 3. The combined time period the relinquished amounts.transferred to the EAT. The agreement must property and replacement property areprovide all the following. held in the QEAA cannot be longer than Example. You exchange real estate held for

180 days. investment with an adjusted basis of $8,000 for• The EAT is holding the property for yourother real estate you want to hold for investment.benefit in order to facilitate an exchangeThe fair market value of the real estate youExchange accommodation titleholder (EAT).under the like-kind exchange rules andreceive is $10,000. You also receive $1,000 inThe EAT must meet all the following require-Revenue Procedure 2000-37, as modifiedcash. You paid $500 in exchange expenses.ments.by Revenue Procedure 2004-51.Although the total gain realized on the transac-• Hold qualified indications of ownership• You and the EAT agree to report the action is $2,500, only $500 ($1,000 cash received

(defined next) at all times from the date ofquisition, holding, and disposition of the minus the $500 exchange expenses) is recog-acquisition of the property until the prop-property on your federal income tax re- nized (included in your income).erty is transferred (as described in (2),turns in a manner consistent with theearlier).agreement. Assumption of liabilities. If the other party to

a nontaxable exchange assumes any of your• Be someone other than you or a disquali-• The EAT will be treated as the beneficialliabilities, you will be treated as if you receivedfied person (as defined in 2(b), earlier).owner of the property for all federal in-cash in the amount of the liability. For morecome tax purposes. • Be subject to federal income tax. If the information on the assumption of liabilities, see

EAT is treated as a partnership or S cor- section 357(d) of the Internal Revenue Code.Property can be treated as being held in a poration, more than 90% of its interests orQEAA even if the accounting, regulatory, or stock must be owned by partners or Example. The facts are the same as in thestate, local, or foreign tax treatment of the ar- shareholders who are subject to federal previous example, except the property you giverangement between you and the EAT is different income tax. up is subject to a $3,000 mortgage for which youfrom the treatment required by the list above.

were personally liable. The other party in theQualified indications of ownership. Qual-Bona fide intent. When the qualified indica- trade has agreed to pay off the mortgage. Figure

ified indications of ownership are any of thetions of ownership of the property are trans- the gain realized as follows.following.ferred to the EAT, it must be your bona fide

FMV of like-kind property received . . $10,000intent that the property held by the EAT repre- • Legal title to the property.Cash . . . . . . . . . . . . . . . . . . . . . . 1,000sents either replacement property or relin-

• Other indications of ownership of the prop- Mortgage treated as assumed byquished property in an exchange intended toother party . . . . . . . . . . . . . . . . . . 3,000erty that are treated as beneficial owner-qualify for nonrecognition of gain (in whole or inTotal received . . . . . . . . . . . . . . . . $14,000ship of the property under principles ofpart) or loss under the like-kind exchange rules.Minus: Exchange expenses . . . . . . . (500)commercial law (for example, a contractAmount realized . . . . . . . . . . . . . . $13,500for deed).Time limits for identifying and transferringMinus: Adjusted basis of property youproperty. Under a QEAA, the following time • Interests in an entity that is disregarded as transferred . . . . . . . . . . . . . . . . . . (8,000)limits for identifying and transferring the property an entity separate from its owner for fed- Realized gain . . . . . . . . . . . . . . . . $5,500must be met. eral income tax purposes (for example, a

The realized gain is taxed only up to $3,500,single member limited liability company)1. No later than 45 days after the transfer of the sum of the cash received ($1,000 − $500and that holds either legal title to the prop-qualified indications of ownership of the re- exchange expenses) and the mortgageerty or other indications of ownership.placement property to the EAT; you must ($3,000).identify the relinquished property in a man-ner consistent with the principles for de- Other permissible arrangements. Property Unlike property given up. If, in addition toferred exchanges. See Identification will not fail to be treated as being held in a QEAA like-kind property, you give up unlike property,




Truck R . . . . . . . . . . . . 1,400 250you must recognize gain or loss on the unlike • Stocks, bonds, notes, or other securitiesCash . . . . . . . . . . . . . . 400or evidences of debt or interest.property you give up. The gain or loss is equal to

the difference between the fair market value of • Interests in a partnership. All liabilities assumed by Ben ($1,000) arethe unlike property and the adjusted basis of theoffset by all liabilities of which he is relieved• Certificates of trust or beneficial interests.unlike property.($500), resulting in a difference of $500. The

• Choses in action. difference is allocated among Ben’s exchangeExample. You exchange stock and real es-groups in proportion to the fair market value oftate you held for investment for real estate youthe properties received in the exchange groupsExample. Ben exchanges computer A (as-also intend to hold for investment. The stock youas follows.set class 00.12), automobile A (asset classtransfer has a fair market value of $1,000 and an

00.22), and truck A (asset class 00.241) foradjusted basis of $4,000. The real estate you • $131 ($500 × $1,600 ÷ $6,100) is allo-computer R (asset class 00.12), automobile Rexchange has a fair market value of $19,000 cated to the first exchange group (com-(asset class 00.22), truck R (asset classand an adjusted basis of $15,000. The real es- puters A and R). The fair market value of00.241), and $400. All properties transferredtate you receive has a fair market value of computer R is reduced to $1,469 ($1,600were used in Ben’s business. Similarly, all$20,000. You do not recognize gain on the ex- − $131).properties received will be used in his business.change of the real estate because it qualifies as • $254 ($500 × $3,100 ÷ $6,100) is allo-The first exchange group consists of com-a nontaxable exchange. However, you must rec-

cated to the second exchange group (au-puters A and R, the second exchange groupognize (report on your return) a $3,000 loss ontomobiles A and R). The fair market valueconsists of automobiles A and R, and the thirdthe stock because it is unlike property.of automobile R is reduced to $2,846exchange group consists of trucks A and R.($3,100 − $254).Basis of property received. The total basis Treatment of liabilities. Offset all liabilities

for all properties (other than money) you receive • $115 ($500 × $1,400 ÷ $6,100) is allo-you assume as part of the exchange against allin a partially nontaxable exchange is the total cated to the third exchange group (trucksliabilities of which you are relieved. Offset theseadjusted basis of the properties you give up, with A and R). The fair market value of truck Rliabilities whether they are recourse or nonre-the following adjustments. is reduced to $1,285 ($1,400 − $115).course and regardless of whether they are se-

cured by or otherwise relate to specific property In each exchange group, Ben uses the reduced1. Add both the following amounts.transferred or received as part of the exchange. fair market value of the properties received to

If you assume more liabilities than you area. Any additional costs you incur. figure the exchange group’s surplus or defi-relieved of, allocate the difference among the ciency and to determine whether a residualb. Any gain you recognize on the ex- exchange groups in proportion to the total fair group has been created.change. market value of the properties you received inthe exchange groups. The difference allocated Residual group. A residual group is created if2. Subtract both the following amounts. to each exchange group may not be more than the total fair market value of the properties trans-the total fair market value of the properties you ferred in all exchange groups differs from thea. Any money you receive.received in the exchange group. total fair market value of the properties received

b. Any loss you recognize on the ex- The amount of the liabilities allocated to an in all exchange groups after taking into accountchange. exchange group reduces the total fair market the treatment of liabilities (discussed earlier).

value of the properties received in that ex- The residual group consists of money or otherAllocate this basis first to the unlike property, change group. This reduction is made in deter- property that has a total fair market value equalother than money, up to its fair market value on mining whether the exchange group has a to that difference. It consists of either money orthe date of the exchange. The rest is the basis surplus or a deficiency. (See Exchange group other property transferred in the exchange orof the like-kind property. surplus and deficiency, later.) This reduction is money or other property received in the ex-

also made in determining whether a residual change, but not both.group is created. (See Residual group, later.) Other property includes the following items.Multiple Property Exchanges If you are relieved of more liabilities than you

• Stock in trade or other property held pri-assume, treat the difference as cash, generalUnder the like-kind exchange rules, you gener- marily for sale.deposit accounts (other than certificates of de-ally must make a property-by-property compari-posit), and similar items when making alloca- • Stocks, bonds, notes, or other securitiesson to figure your recognized gain and the basistions to the residual group, discussed later. or evidences of debt or interest.of the property you receive in the exchange.

The treatment of liabilities and any differ-However, for exchanges of multiple properties, • Interests in a partnership.ences between amounts you assume andyou do not make a property-by-property com-amounts you are relieved of will be the same • Certificates of trust or beneficial interests.parison if you do either of the following.even if the like-kind exchange treatment applies

• Choses in action.to only part of a larger transaction. If so, deter-• Transfer and receive properties in two ormine the difference in liabilities based on allmore exchange groups. Other property also includes property trans-liabilities you assume or are relieved of as part of ferred that is not of a like kind or like class with• Transfer or receive more than one prop- the larger transaction. any property received, and property receivederty within a single exchange group.

that is not of a like kind or like class with anyExample. The facts are the same as in theIn these situations, you figure your recognized property transferred.

preceding example. In addition, the fair marketgain and the basis of the property you receive byFor asset acquisitions occurring after Marchvalue of and liabilities secured by each propertycomparing the properties within each exchange

15, 2001, money and properties allocated to theare as follows.group.residual group are considered to come from thefollowing assets in the following order.FairExchange groups. Each exchange group

Marketconsists of properties transferred and received1. Cash and general deposit accounts (in-Value Liabilityin the exchange that are of like kind or like class.

Ben Transfers: cluding checking and savings accounts but(See Like-Kind Property, earlier.) If propertyexcluding certificates of deposit). Also, in-could be included in more than one exchange

Computer A . . . . . . . . . $1,500 $ -0- clude here excess liabilities of which yougroup, you can include it in any one of those Automobile A . . . . . . . . 2,500 500 are relieved over the amount of liabilitiesgroups. However, the following may not be in- Truck A . . . . . . . . . . . . 2,000 -0- you assume.cluded in an exchange group.2. Certificates of deposit, U.S. GovernmentBen Receives:• Money.

securities, foreign currency, and actively• Stock in trade or other property held pri- traded personal property, including stockComputer R . . . . . . . . . $1,600 $ -0-

marily for sale. Automobile R . . . . . . . . 3,100 750 and securities.




3. Accounts receivable, other debt instru- value of the properties transferred in an ex- The total gain recognized by Karen in thements, and assets that you mark to market change group that is more than the total fair exchange is the sum of the gains recognizedat least annually for federal income tax market value of the properties received in that with respect to both exchange groups ($0 +purposes. However, see section exchange group (minus any excess liabilities $1,050), or $1,050.1.338-6(b)(2)(iii) of the regulations for ex- you assume that are allocated to that exchange

Basis of properties received. The total basisceptions that apply to debt instruments is- group).of properties received in each exchange groupsued by persons related to a targetis the sum of the following amounts.Example. Karen exchanges computer Acorporation, contingent debt instruments,

(asset class 00.12) and automobile A (assetand debt instruments convertible into stock 1. The total adjusted basis of the transferredclass 00.22), both of which she used in heror other property. properties within that exchange group.business, for printer B (asset class 00.12) and

4. Property of a kind that would properly be 2. Your recognized gain on the exchangeautomobile B (asset class 00.22), both of whichincluded in inventory if on hand at the end group.she will use in her business. Karen’s adjustedof the tax year or property held by the basis and the fair market value of the exchanged 3. The excess liabilities you assume that aretaxpayer primarily for sale to customers in properties are as follows. allocated to the group.the ordinary course of business.

4. The exchange group surplus (or minus theFair5. Assets other than those listed in (1), (2),exchange group deficiency).Adjusted Market(3), (4), (6) and (7).

Basis ValueYou allocate the total basis of each exchange6. All section 197 intangibles except goodwill Karen Transfers:group proportionately to each property receivedand going concern value.in the exchange group according to theAutomobile A . . . . . . . . . $1,500 $4,0007. Goodwill and going concern value. property’s fair market value.Computer A . . . . . . . . . . 375 1,000

The basis of each property received withinWithin each category, you can choose whichthe residual group (other than money) is equal toKaren Receives:properties to allocate to the residual group. If anits fair market value.asset described in any of the categories above,

Printer B . . . . . . . . . . . . . . . . . . . . $2,050except (1), is includible in more than one cate-Example. Based on the facts in the two pre-Automobile B . . . . . . . . . . . . . . . . 2,950gory, include it in the lower number category.

vious examples, the bases of the properties re-For example, if an asset is described in both (3) The first exchange group consists of computer A ceived by Karen in the exchange, printer B andand (4), include it in (3). and printer B. It has an exchange group surplus automobile B, are determined in the followingof $1,050 because the fair market value of manner.Example. Fran exchanges computer A (as- printer B ($2,050) is more than the fair market The basis of the property received in the firstset class 00.12) and automobile A (asset class value of computer A ($1,000) by that amount. exchange group is $1,425. This is the sum of the00.22) for printer B (asset class 00.12), automo- The second exchange group consists of au- following amounts.bile B (asset class 00.22), corporate stock, and tomobile A and automobile B. It has an ex-

$500. Fran used computer A and automobile A change group deficiency of $1,050 because the 1. Adjusted basis of the property transferredin her business and will use printer B and auto- fair market value of automobile A ($4,000) is within that exchange group ($375).mobile B in her business. more than the fair market value of automobile BThis transaction results in two exchange 2. Gain recognized for that exchange group($2,950) by that amount.

groups: (1) computer A and printer B, and (2) ($0).automobile A and automobile B. Recognized gain. Gain or loss realized for 3. Excess liabilities assumed allocated to thatThe fair market values of the properties are each exchange group and the residual group is exchange group ($0).as follows. the difference between the total fair market

4. Exchange group surplus ($1,050).value of the transferred properties in that ex-Fair change group or residual group and the total Printer B is the only property received within theMarket

adjusted basis of the properties. For each ex- first exchange group, so the entire basis ofValuechange group, recognized gain is the lesser of $1,425 is allocated to printer B.Fran Transfers:the gain realized or the exchange group defi- The basis of the property received in theciency (if any). Losses are not recognized for an second exchange group is $1,500. This is fig-Computer A . . . . . . . . . . . . . . . $1,000exchange group. The total gain recognized on ured as follows.Automobile A . . . . . . . . . . . . . . 4,000the exchange of like-kind or like-class properties First, add the following amounts.is the sum of all the gain recognized for eachFran Receives:

1. Adjusted basis of the property transferredexchange group.within that exchange group ($1,500).Automobile B . . . . . . . . . . . . . . $2,950 For a residual group, you must recognize the

Printer B . . . . . . . . . . . . . . . . . . 800 entire gain or loss realized. 2. Gain recognized for that exchange groupCorporate Stock . . . . . . . . . . . . 750 For properties you transfer that are not within ($1,050).Cash . . . . . . . . . . . . . . . . . . . . 500 any exchange group or the residual group, fig-

3. Excess liabilities assumed allocated to thature realized and recognized gain or loss asThe total fair market value of the propertiesexchange group ($0).explained under Gain or Loss From Sales andtransferred in the exchange groups ($5,000) is

Exchanges, earlier.$1,250 more than the total fair market value of Then subtract the exchange group deficiencythe properties received in the exchange groups ($1,050).

Example. Based on the facts in the previous($3,750), so there is a residual group in that Automobile B is the only property receivedexample, Karen recognizes gain on the ex-amount. It consists of the $500 cash and the within the second exchange group, so the entirechange as follows.$750 worth of corporate stock. basis ($1,500) is allocated to automobile B.

For the first exchange group, the gain real-ized is the fair market value of computer AExchange group surplus and deficiency.($1,000) minus its adjusted basis ($375), orFor each exchange group, you must determine Like-Kind Exchanges$625. The gain recognized is the lesser of thewhether there is an “exchange group surplus” or Between Related Personsgain realized ($625) or the exchange group defi-“exchange group deficiency.” An exchangeciency ($0), or $0.group surplus is the total fair market value of the Special rules apply to like-kind exchanges be-

properties received in an exchange group (mi- For the second exchange group, the gain tween related persons. These rules affect bothnus any excess liabilities you assume that are realized is the fair market value of automobile A direct and indirect exchanges. Under theseallocated to that exchange group) that is more ($4,000) minus its adjusted basis ($1,500), or rules, if either person disposes of the propertythan the total fair market value of the properties $2,500. The gain recognized is the lesser of the within 2 years after the exchange, the exchangetransferred in that exchange group. An ex- gain realized ($2,500) or the exchange group is disqualified from nonrecognition treatment.change group deficiency is the total fair market deficiency ($1,050), or $1,050. The gain or loss on the original exchange must




be recognized as of the date of the later disposi- • A short sale or other transaction. Insurance Policies and Annuitiestion.

No gain or loss is recognized if you make any ofA put is an option that entitles the holder to sellRelated persons. Under these rules, related the following exchanges.property at a specified price at any time before apersons include, for example, you and a mem- specified future date. • A life insurance contract for another or forber of your family (spouse, brother, sister, par-

an endowment or annuity contract.A short sale involves property you generallyent, child, etc.), you and a corporation in whichdo not own. You borrow the property to deliver toyou have more than 50% ownership, you and a • An endowment contract for an annuitya buyer and, at a later date, buy substantiallypartnership in which you directly or indirectly contract or for another endowment con-identical property and deliver it to the lender.own more than a 50% interest of the capital or tract providing for regular payments begin-

profits, and two partnerships in which you di- ning at a date not later than the beginningrectly or indirectly own more than 50% of the date under the old contract.Exceptions to the rules for related persons.capital interests or profits. The following kinds of property dispositions are • One annuity contract for another if the in-

excluded from these rules.An exchange structured to avoid the sured or annuitant remains the same.related party rules is not a like-kind

• A portion of an annuity contract for a new• Dispositions due to the death of either re-exchange. See Like-Kind ExchangesCAUTION!

annuity contract if the insured or annuitantlated person.Using Qualified Intermediaries, earlier.remains the same.

For more information on related persons, • Involuntary conversions.see Nondeductible Loss under Sales and Ex- If you realize a gain on the exchange of an• Dispositions if it is established to the satis-changes Between Related Persons in chapter 2. endowment contract or annuity contract for a lifefaction of the IRS that neither the ex-

insurance contract or an exchange of an annuitychange nor the disposition had as a mainExample. You used a panel truck in your contract for an endowment contract, you mustpurpose the avoidance of federal incomehouse painting business. Your sister used a recognize the gain.tax.pickup truck in her landscaping business. In For information on transfers and rollovers ofDecember 2003, you exchanged your panel employer-provided annuities, see Publicationtruck plus $200 for your sister’s pickup truck. At Other Nontaxable Exchanges 575, Pension and Annuity Income, or Publica-that time, the fair market value (FMV) of your tion 571, Tax-Sheltered Annuity Plans (403(b)panel truck was $7,000 and its adjusted basis The following discussions describe other ex- Plans).was $6,000. The fair market value of your changes that may not be taxable.

Cash received. The nonrecognition and non-sister’s pickup truck was $7,200 and its adjustedtaxable transfer rules do not apply to a rollover inbasis was $1,000. You realized a gain of $1,000which you receive cash proceeds from the sur-(the $7,200 fair market value of the pickup truck Partnership Interestsrender of one policy and invest the cash in an-minus the $200 you paid minus the $6,000 ad-other policy. However, you can treat a cashExchanges of partnership interests do not qual-justed basis of the panel truck). Your sister real-distribution and reinvestment as meeting theized a gain of $6,200 (the $7,000 fair market ify as nontaxable exchanges of like-kind prop-nonrecognition or nontaxable transfer rules if allvalue of your panel truck plus the $200 you paid erty. This applies regardless of whether they arethe following requirements are met. minus the $1,000 adjusted basis of the pickup general or limited partnership interests or are

truck). interests in the same partnership or different1. When you receive the distribution, the in-However, because this was a like-kind ex- partnerships. However, under certain circum-

surance company that issued the policy orchange, you recognized no gain. Your basis in stances the exchange may be treated as acontract is subject to a rehabilitation, con-the pickup truck was $6,200 (the $6,000 ad- tax-free contribution of property to a partnership. servatorship, insolvency, or similar statejusted basis of the panel truck plus the $200 you See Contribution of Property in Publication 541, proceeding.paid). Your sister recognized gain only to the Partnerships.

extent of the money she received, $200. Her 2. You withdraw all amounts to which you areAn interest in a partnership that has a validbasis in the panel truck was $1,000 (the $1,000 entitled or, if less, the maximum permittedchoice in effect under section 761(a) of the Inter-adjusted basis of the pickup truck minus the under the state proceeding.nal Revenue Code to be excluded from all the$200 received, plus the $200 gain recognized).3. You reinvest the distribution within 60 daysrules of Subchapter K of the Code is treated asIn 2004, you sold the pickup truck to a third

after receipt in a single policy or contractan interest in each of the partnership assets andparty for $7,000. You sold it within 2 years afterissued by another insurance company or innot as a partnership interest. See Exclusionthe exchange, so the exchange is disqualifieda single custodial account.From Partnership Rules in Publication 541.from nonrecognition treatment. On your 2004

tax return, you must report your $1,000 gain on 4. You assign all rights to future distributionsthe 2003 exchange. You also report a loss on to the new issuer for investment in the newU.S. Treasury Notes or Bondsthe sale of $200 (the adjusted basis of the policy or contract if the distribution was re-pickup truck, $7,200 (its $6,200 basis plus the stricted by the state proceeding.Certain issues of U.S. Treasury obligations may$1,000 gain recognized), minus the $7,000 real-

be exchanged for certain other issues desig- 5. You would have qualified under the non-ized from the sale).nated by the Secretary of the Treasury with no recognition or nontaxable transfer rules ifIn addition, your sister must report on hergain or loss recognized on the exchange. See you had exchanged the affected policy or2004 tax return the $6,000 balance of her gainU.S. Treasury Bills, Notes, and Bonds under contract for the new one.on the 2003 exchange. Her adjusted basis in theInterest Income in Publication 550 for more in-panel truck is increased to $7,000 (its $1,000 If you do not reinvest all of the cash distribution,formation on the tax treatment of income frombasis plus the $6,000 gain recognized). the rules for partially nontaxable exchanges, dis-these investments. cussed earlier, apply.Two-year holding period. The 2-year holding

In addition to meeting these five require-For other information on these notesperiod begins on the date of the last transfer ofments, you must do both the following.and bonds, call the Bureau of the Pub-property that was part of the like-kind exchange.

lic Debt at 1-800-722-2678, or write toIf the holder’s risk of loss on the property is 1. Give to the issuer of the new policy orthe following address.substantially diminished during any period, how- contract a statement that includes all theBureau of the Public Debtever, that period is not counted toward the following information.Attn: Marketable Assistance Branch2-year holding period. The holder’s risk of lossP.O. Box 426on the property is substantially diminished by a. The gross amount of cash distributed.

any of the following events. Parkersburg, WV 26102-0426 b. The amount reinvested.• The holding of a put on the property. Or, visit www.publicdebt.treas.gov on c. Your investment in the affected policy

the Internet.• The holding by another person of a right to or contract on the date of the initial cashacquire the property. distribution.




2. Attach the following items to your timely 85% of the outstanding stock. No gain is recog- up to the difference. However, if the liabili-filed tax return for the year of the initial nized on the exchange of property. However, ties assumed give rise to a deductiondistribution. you recognize ordinary income of $3,000 as when paid, such as a trade account pay-

payment for services you rendered to the corpo- able or interest, no gain is recognized.a. A statement titled “Election under Rev. ration. • If there is no good business reason for theProc. 92-44” that includes the name of

corporation to assume your liabilities, or ifProperty of relatively small value. The termthe issuer and the policy number (orproperty does not include property of a relatively your main purpose in the exchange is tosimilar identifying number) of the newsmall value when it is compared to the value ofpolicy or contract. avoid federal income tax, the assumptionstock and securities already owned or to be is treated as if you received money in theb. A copy of the statement given to the received for services by the transferor if the main amount of the liabilities.issuer of the new policy or contract. purpose of the transfer is to qualify for the non-

For more information on the assumption of liabil-recognition of gain or loss by other transferors.ities, see section 357(d) of the Internal RevenueProperty transferred will not be considered toCode.be of relatively small value if its fair market valueProperty Exchanged for Stock

is at least 10% of the fair market value of theExample. You transfer property to a corpo-stock and securities already owned or to beIf you transfer property to a corporation in ex- ration for stock. Immediately after the transfer,received for services by the transferor.change for stock in that corporation (other than

you control the corporation. You also receivenonqualified preferred stock, described later), Stock received in disproportion to property $10,000 in the exchange. Your adjusted basis inand immediately afterward you are in control of transferred. If a group of transferors ex- the transferred property is $20,000. The stockthe corporation, the exchange is usually not tax- change property for corporate stock, each trans- you receive has a fair market value (FMV) ofable. This rule applies both to individuals and to feror does not have to receive stock in $16,000. The corporation also assumes agroups who transfer property to a corporation. It proportion to his or her interest in the property $5,000 mortgage on the property for which youdoes not apply in the following situations. transferred. If a disproportionate transfer takes are personally liable. Gain is realized as follows.place, it will be treated for tax purposes in accor-• The corporation is an investment com-dance with its true nature. It may be treated as ifpany. FMV of stock received . . . . . . . . . $16,000the stock were first received in proportion and Cash received . . . . . . . . . . . . . . . 10,000• You transfer the property in a bankruptcy then some of it used to make gifts, pay compen- Liability assumed by corporation . . . 5,000or similar proceeding in exchange for sation for services, or satisfy the transferor’s Total received . . . . . . . . . . . . . . . $31,000stock used to pay creditors. obligations. Minus: Adjusted basis of property

transferred . . . . . . . . . . . . . . . . . 20,000• The stock is received in exchange for theMoney or other property received. If, in an Realized gain . . . . . . . . . . . . . . . $11,000corporation’s debt (other than a security)otherwise nontaxable exchange of property foror for interest on the corporation’s debt

The liability assumed is not treated as moneycorporate stock, you also receive money or(including a security) that accrued whileproperty other than stock, you may have to rec- or other property. The recognized gain is limitedyou held the debt.ognize gain. You must recognize gain only up to to $10,000, the cash received.the amount of money plus the fair market value

Control of a corporation. To be in control of a of the other property you receive. The rules forcorporation, you or your group of transferors figuring the recognized gain in this situation gen-must own, immediately after the exchange, at erally follow those for a partially nontaxable ex- Transfers to Spouseleast 80% of the total combined voting power of change discussed earlier under Like-Kindall classes of stock entitled to vote and at least Exchanges. If the property you give up includes No gain or loss is recognized on a transfer of80% of the outstanding shares of each class of depreciable property, the recognized gain may property from an individual to (or in trust for thenonvoting stock. have to be reported as ordinary income from benefit of) a spouse, or a former spouse if inci-

depreciation. See chapter 3. No loss is recog-The control requirement can be met dent to divorce. This rule does not apply to thenized.even though there are successive following.

transfers of property and stock. For Nonqualified preferred stock. Nonquali-TIP

• The recipient of the transfer is a nonresi-more information, see Revenue Ruling 2003-51 fied preferred stock is treated as property otherdent alien.in Internal Revenue Bulletin No. 2003-21. than stock. Generally, it is preferred stock with

any of the following features. • A transfer in trust to the extent the liabili-Example 1. You and Bill Jones buy property ties assumed and the liabilities on the• The holder has the right to require the

for $100,000. You both organize a corporation property are more than the property’s ad-issuer or a related person to redeem orwhen the property has a fair market value of justed basis.buy the stock.$300,000. You transfer the property to the cor- • A transfer of certain stock redemptions, as• The issuer or a related person is requiredporation for all its authorized capital stock, which

discussed in section 1.1041-2 of the regu-to redeem or buy the stock.has a par value of $300,000. No gain is recog-lations.nized by you, Bill, or the corporation. • The issuer or a related person has the

right to redeem or buy the stock and, on Any transfer of property to a spouse or formerExample 2. You and Bill transfer the prop- the issue date, it is more likely than not spouse on which gain or loss is not recognized iserty with a basis of $100,000 to a corporation in that the right will be exercised. treated by the recipient as a gift and is notexchange for stock with a fair market value ofconsidered a sale or exchange. The recipient’s• The dividend rate on the stock varies with$300,000. This represents only 75% of eachbasis in the property will be the same as thereference to interest rates, commodityclass of stock of the corporation. The other 25%adjusted basis of the property to the giver imme-prices, or similar indices.was already issued to someone else. You anddiately before the transfer. This carryover basisBill recognize a taxable gain of $200,000 on the For a detailed definition of nonqualified pre-rule applies whether the adjusted basis of thetransaction. ferred stock, see section 351(g)(2) of the Inter-transferred property is less than, equal to, ornal Revenue Code.Services rendered. The term property doesgreater than either its fair market value at thenot include services rendered or to be rendered Liabilities. If the corporation assumes your time of transfer or any consideration paid by theto the issuing corporation. The value of stock liabilities, the exchange generally is not treated recipient. This rule applies for determining lossreceived for services is income to the recipient. as if you received money or other property. as well as gain. Any gain recognized on a trans-

There are two exceptions to this treatment. fer in trust increases the basis.Example. You transfer property worthFor more information on transfers to a$35,000 and render services valued at $3,000 to • If the liabilities the corporation assumes

spouse, see Property Settlements in Publicationa corporation in exchange for stock valued at are more than your adjusted basis in the504, Divorced or Separated Individuals.$38,000. Right after the exchange, you own property you transfer, gain is recognized




Different rules apply when the stock is held by a If this amount is equal to or more than theamount of your gain, you must recognize the fullpartnership, S corporation, regulated invest-Rollover of Gainamount of your gain. If this amount is less thanment company, or common trust fund.the amount of your gain, you can postpone theFrom Publicly Your gain that is eligible for the exclusionrest of your gain by adjusting the basis of yourfrom the stock of any one issuer is limited to thereplacement property as described next.Traded Securities greater of the following amounts.

• Ten times your basis in all qualified stockYou can choose to roll over a capital gain from Basis of replacement property. You mustof the issuer you sold or exchanged duringthe sale of publicly traded securities (securities subtract the amount of postponed gain from thethe year.traded on an established securities market) into basis of the qualified empowerment zone assets

a specialized small business investment com- you bought as replacement property.• $10 million ($5 million for married individu-pany (SSBIC). If you make this choice, the gain als filing separately) minus the gain fromfrom the sale is recognized only to the extent the More information. For more informationthe stock of the same issuer you used toamount realized is more than the cost of the about empowerment zones, see Publicationfigure your exclusion in earlier years.SSBIC common stock or partnership interest 954, Tax Incentives for Distressed Communi-bought during the 60-day period beginning on ties. For more information about this rollover of

More information. For more information onthe date of the sale. You must reduce your basis gain, see section 1397B of the Internal Revenuesales of small business stock, see chapter 4 ofin the SSBIC stock or partnership interest by the Code.Publication 550.gain not recognized.

The gain that can be rolled over during anytax year is limited. For individuals, the limit is thelesser of the following amounts. Exclusion of GainRollover of Gain• $50,000 ($25,000 for married individuals From Sale of DC Zonefiling separately). From Sale of

• $500,000 ($250,000 for married individu- AssetsEmpowerment Zoneals filing separately) minus the gain rolledover in all earlier tax years. If you sold or exchanged a District of ColumbiaAssets

Enterprise Zone (DC Zone) asset that you heldFor more information, see chapter 4 of Publica-for more than 5 years, you may be able totion 550. You may qualify for a tax-free rollover of certainexclude the “qualified capital gain”. The qualifiedgains from the sale of qualified empowermentFor C corporations, the limit is the lesser of the gain is, generally, any gain recognized in a tradezone assets. This means that if you buy certainfollowing amounts. or business that you would otherwise include onreplacement property and make the choice de-Form 4797, Part I. This exclusion also applies to• $250,000. scribed in this section, you postpone part or all ofan interest in, or property of, certain businesses

the recognition of your gain.• $1 million minus the gain rolled over in all operating in the District of Columbia.You can make this choice if you meet all theearlier tax years.

following tests. DC Zone asset. A DC Zone asset is any of thefollowing:1. You hold a qualified empowerment zone

asset for more than 1 year and sell it at a • DC Zone business stock.Sales of Small gain.• DC Zone partnership interest.

2. Your gain from the sale is a capital gain.Business Stock • DC Zone business property.3. During the 60-day period beginning on the

If you sell qualified small business stock, you date of the sale, you buy a replacementQualified capital gain. The qualified capitalmay be able to roll over your gain tax free or qualified empowerment zone asset in thegain is any gain recognized on the sale or ex-exclude part of the gain from your income. Quali- same zone as the asset sold.change of a DC Zone asset that is a capitalfied small business stock is stock originally is-

Any part of the gain that is ordinary income asset or property used in a trade or business. Itsued by a qualified small business after Augustcannot be postponed and must be recognized. does not include any of the following gains.10, 1993, that meets all 7 tests listed in chapter 4

of Publication 550. • Gain treated as ordinary income underQualified empowerment zone asset. ThisRollover of gain. You can choose to roll over section 1245;means certain stock or partnership interests ina capital gain from the sale of qualified small an enterprise zone business. It also includes • Gain treated as unrecaptured sectionbusiness stock held longer than 6 months into certain tangible property used in an enterprise 1250 gain. The section 1250 gain must beother qualified small business stock. This choice zone business. You must have acquired the figured as if it applied to all depreciationis not allowed to C corporations. If you make this asset after December 21, 2000. rather than the additional depreciation;choice, the gain from the sale generally is recog-

• Gain attributable to real property, or annized only to the extent the amount realized is Amount of gain recognized. If you make theintangible asset, which is not an integralmore than the cost of the replacement qualified choice described in this section, you must rec-part of a DC Zone business; andsmall business stock bought within 60 days of ognize gain only up to the following amount:

the date of sale. You must reduce your basis in • Gain from a related-party transaction. See1. The amount realized on the sale, minusthe replacement qualified small business stock Sales and Exchanges Between Relatedby the gain not recognized. 2. The cost of the qualified empowerment Persons in chapter 2.

zone asset that you bought during theExclusion of gain. You may be able to ex-60-day period beginning on the date ofclude from your gross income one-half your gain See Publication 954, Tax Incentives for Dis-sale (and did not previously take into ac-from the sale or exchange of qualified small tressed Communities, and section 1400B forcount in rolling over gain on an earlier salebusiness stock held by you longer than 5 years. more details on DC Zone assets and specialof qualified empowerment zone assets).This exclusion is not allowed to C corporations. rules.




5. A copyright; a literary, musical, or artisticcomposition; a letter; a memorandum; orCapital Assetssimilar property (such as drafts of2. speeches, recordings, transcripts, manu-Almost everything you own and use for personalscripts, drawings, or photographs)purposes or investment is a capital asset. For

exceptions, see Noncapital Assets, later. a. Created by your personal efforts,The following items are examples of capitalOrdinary b. Prepared or produced for you (in theassets.

case of a letter, memorandum, or simi-• Stocks and bonds. lar property), oror Capital• A home owned and occupied by you and c. Acquired from a person who created

your family. the property or for whom the propertyGain or Losswas prepared under circumstances (for• Timber grown on your home property orexample, by gift) entitling you to the ba-investment property, even if you makesis of the person who created the prop-casual sales of the timber.erty, or for whom it was prepared orIntroduction • Household furnishings. produced.

You must classify your gains and losses as • A car used for pleasure or commuting.either ordinary or capital (and your capital gains 6. U.S. Government publications you got• Coin or stamp collections.or losses as either short-term or long-term). You from the government for free or for lessmust do this to figure your net capital gain or than the normal sales price or that you• Gems and jewelry.loss. acquired under circumstances entitling you• Gold, silver, and other metals.For individuals, a net capital gain may be to the basis of someone who got the publi-taxed at a lower tax rate than ordinary income. cations for free or for less than the normalSee Capital Gains Tax Rates in chapter 4. Your Personal-use property. Property held for sales price.deduction for a net capital loss may be limited. personal use is a capital asset. Gain from a sale

7. Any commodities derivative financial in-See Treatment of Capital Losses in chapter 4. or exchange of that property is a capital gain.strument (discussed later) held by a com-Loss from the sale or exchange of that propertymodities derivatives dealer unless it meetsis not deductible. You can deduct a loss relatingCapital gain or loss. Generally, you will haveboth the following requirements.to personal-use property only if it results from aa capital gain or loss if you sell or exchange a

casualty or theft.capital asset. You also may have a capital gain if a. It is established to the satisfaction of theyour section 1231 transactions result in a net IRS that the instrument has no connec-

Investment property. Investment propertygain. tion to the activities of the dealer as a(such as stocks and bonds) is a capital asset, dealer.Section 1231 transactions. Section 1231 and a gain or loss from its sale or exchange is a

transactions are sales and exchanges of prop- b. The instrument is clearly identified incapital gain or loss. This treatment does noterty held longer than 1 year and either used in a the dealer’s records as meeting (a) byapply to property used to produce rental income.trade or business or held for the production of the end of the day on which it was ac-See Business assets, later, under Noncapitalrents or royalties. They also include certain in- quired, originated, or entered into.Assets.voluntary conversions of business or investmentproperty, including capital assets. See Section 8. Any hedging transaction (defined later)Release of restriction on land. Amounts you1231 Gains and Losses in chapter 3 for more that is clearly identified as a hedging trans-receive for the release of a restrictive covenantinformation. action by the end of the day on which itin a deed to land are treated as proceeds from

was acquired, originated, or entered into.the sale of a capital asset.Topics 9. Supplies of a type you regularly use orThis chapter discusses: consume in the ordinary course of your

trade or business.• Capital assets Noncapital Assets

Property held mainly for sale to customers.• Noncapital assetsA noncapital asset is property that is not a capi- Stock in trade, inventory, and other property you

• Sales and exchanges between tal asset. The following kinds of property are not hold mainly for sale to customers in your trade orrelated persons capital assets. business are not capital assets. Inventories are

discussed in Publication 538.• Other dispositions 1. Property held mainly for sale to customersBusiness assets. Real property and depre-or property that will physically become partciable property used in your trade or business orof merchandise for sale to customers. ThisUseful Itemsas rental property (including section 197 in-includes stock in trade, inventory, andYou may want to see:tangibles defined later under Dispositions of In-other property you hold mainly for sale totangible Property) are not capital assets. Thecustomers in your trade or business. In-Publicationsale or disposition of business property is dis-ventories are discussed in Publication 538,cussed in chapter 3.Accounting Periods and Methods.❏ 550 Investment Income and Expenses

Letters and memorandums. Letters, memo-2. Accounts or notes receivable acquired in❏ 954 Tax Incentives for Distressedrandums, and similar property (such as drafts ofthe ordinary course of a trade or businessCommunitiesspeeches, recordings, transcripts, manuscripts,for services rendered or from the sale ofdrawings, or photographs) are not treated asany properties described in (1).Form (and Instructions)capital assets (as discussed earlier) if your per-

3. Depreciable property used in your trade or❏ Schedule D (Form 1040) Capital Gains sonal efforts created them or if they were pre-

business or as rental property (includingand Losses pared or produced for you. Nor is this property asection 197 intangibles defined later ), capital asset if your basis in it is determined by

❏ 4797 Sales of Business Property even if the property is fully depreciated (or reference to the person who created it or theamortized). Sales of this type of property

❏ 8594 Asset Acquisition Statement Under person for whom it was prepared. For this pur-are discussed in chapter 3.Section 1060 pose, letters and memorandums addressed to

4. Real property used in your trade or busi- you are considered prepared for you. If letters orSee chapter 5 for information about getting ness or as rental property, even if the memorandums are prepared by persons under

publications and forms. property is fully depreciated. your administrative control, they are considered

Chapter 2 Ordinary or Capital Gain or Loss Page 19



prepared for you whether or not you review 3. An executor and a beneficiary of an estate partnership, estate, or trust is consideredthem. unless the sale or exchange is in satisfac- owned proportionately by or for its share-

tion of a pecuniary bequest. holders, partners, or beneficiaries. (How-Commodi t i es der iva t i ve f inanc ia lever, for a partnership interest owned by orinstrument. A commodities derivative finan- 4. An employer (or any person related to thefor a C corporation, this applies only tocial instrument is a commodities contract or employer under rules (1), (2), or (3)) and ashareholders who directly or indirectly ownother financial instrument for commodities welfare benefit fund (within the meaning of5% or more in value of the stock of the(other than a share of corporate stock, a benefi- section 419(e) of the Internal Revenuecorporation.)cial interest in a partnership or trust, a note, Code) that is controlled directly or indi-

bond, debenture, or other evidence of indebted- rectly by the employer (or any person re- 2. An individual is considered as owning theness, or a section 1256 contract) the value or lated to the employer). stock or partnership interest directly or in-settlement price of which is calculated or deter- directly owned by or for his or her family.A person’s controlled entity is either of themined by reference to a specified index (as Family includes only brothers, sisters,following.defined in section 1221(b) of the Internal Reve- half-brothers, half-sisters, spouse, ances-nue Code). tors, and lineal descendants.1. A corporation in which more than 50% of

the value of all outstanding stock, or aCommodities derivative dealer. A com- 3. For purposes of applying (1) or (2), stockpartnership in which more than 50% of themodities derivative dealer is a person who regu- or a partnership interest constructivelycapital interest or profits interest, is directlylarly offers to enter into, assume, offset, assign, owned by a person under (1) is treated asor indirectly owned by or for that person.or terminate positions in commodities derivative actually owned by that person. But stock or

financial instruments with customers in the ordi- a partnership interest constructively owned2. An entity whose relationship with that per-nary course of a trade or business. by an individual under (2) is not treated asson is one of the following.

owned by the individual for reapplying (2)Hedging transaction. A hedging transactionto make another person the constructivea. A corporation and a partnership if theis any transaction you enter into in the normalowner of that stock or partnership interest.same persons own more than 50% incourse of your trade or business primarily to

value of the outstanding stock of themanage any of the following.corporation and more than 50% of the Nondeductible Losscapital interest or profits interest in the1. Risk of price changes or currency fluctua-partnership.tions involving ordinary property you hold A loss on the sale or exchange of property be-

or will hold. b. Two corporations that are members of tween related persons is not deductible. Thisthe same controlled group as defined in applies to both direct and indirect transactions,2. Risk of interest rate or price changes orsection 1563(a) of the Internal Revenue but not to distributions of property from a corpo-currency fluctuations for borrowings youCode, except that “more than 50%” is ration in a complete liquidation. The followingmake or will make, or ordinary obligationssubstituted for “at least 80%” in that def- are related persons. you incur or will incur.inition.

1. Members of a family, including only broth-c. Two S corporations, if the same per- ers, sisters, half-brothers, half-sisters,

sons own more than 50% in value of spouse, ancestors (parents, grandparents,the outstanding stock of each corpora-Sales and Exchanges etc.), and lineal descendants (children,tion. grandchildren, etc.).Between Related d. Two corporations, one of which is an S 2. An individual and a corporation if the indi-corporation, if the same persons own vidual directly or indirectly owns more thanPersons more than 50% in value of the outstand- 50% in value of the outstanding stock ofing stock of each corporation. the corporation.This section discusses the rules that may apply

to the sale or exchange of property between 3. Two corporations that are members of therelated persons. If these rules apply, gains may Controlled partnership transaction. A gain same controlled group as defined in sec-be treated as ordinary income and losses may recognized in a controlled partnership transaction 267(f) of the Internal Revenue Code.not be deductible. See Transfers to Spouse in tion may be ordinary income. The gain is ordi-

4. A trust fiduciary and a corporation if thechapter 1 for rules that apply to spouses. nary income if it results from the sale ortrust or the grantor of the trust directly orexchange of property that, in the hands of theindirectly owns more than 50% in value ofGain Is Ordinary Income party who receives it, is a noncapital asset suchthe outstanding stock of the corporation.as trade accounts receivable, inventory, stock in

If a gain is recognized on the sale or exchange trade, or depreciable or real property used in a 5. A grantor and fiduciary, and the fiduciaryof property to a related person, the gain may be trade or business. and beneficiary, of any trust.ordinary income even if the property is a capital A controlled partnership transaction is a 6. Fiduciaries of two different trusts, and theasset. It is ordinary income if the sale or ex- transaction directly or indirectly between either fiduciary and beneficiary of two differentchange is a depreciable property transaction or of the following pairs of entities. trusts, if the same person is the grantor ofa controlled partnership transaction.

both trusts.• A partnership and a partner who directly orDepreciable property transaction. Gain on indirectly owns more than 50% of the capi- 7. A tax-exempt educational or charitable or-the sale or exchange of property, including a tal interest or profits interest in the partner- ganization and a person who directly orleasehold or a patent application, that is depre- ship. indirectly controls the organization, or aciable property in the hands of the person who

member of that person’s family.• Two partnerships, if the same persons di-receives it is ordinary income if the transaction isrectly or indirectly own more than 50% ofeither directly or indirectly between any of the 8. A corporation and a partnership if thethe capital interests or profits interests infollowing pairs of entities. same persons own more than 50% inboth partnerships. value of the outstanding stock of the cor-1. A person and the person’s controlled entity

poration and more than 50% of the capitalor entities.interest or profits interest in the partner-Determining ownership. In the transactions

2. A taxpayer and any trust in which the tax- ship.under Depreciable property transaction andpayer (or his or her spouse) is a benefi- Controlled partnership transaction, earlier, use 9. Two S corporations if the same personsciary unless the beneficiary’s interest in the the following rules to determine the ownership of own more than 50% in value of the out-trust is a remote contingent interest; that stock or a partnership interest. standing stock of each corporation.is, the value of the interest computed actu-

1. Stock or a partnership interest directly orarially is 5% or less of the value of the trust 10. Two corporations, one of which is an Sindirectly owned by or for a corporation,property. corporation, if the same persons own more

Page 20 Chapter 2 Ordinary or Capital Gain or Loss



than 50% in value of the outstanding stock Indirect transactions. You cannot deduct Corporate liquidations. Corporate liquida-of each corporation. your loss on the sale of stock through your tions of property generally are treated as a sale

broker if under a prearranged plan a related or exchange. Gain or loss generally is recog-11. An executor and a beneficiary of an estateperson or entity buys the same stock you had nized by the corporation on a liquidating sale ofunless the sale or exchange is in satisfac-owned. This does not apply to a cross-trade its assets. Gain or loss generally is recognizedtion of a pecuniary bequest.between related parties through an exchange also on a liquidating distribution of assets as if

12. Two partnerships if the same persons di- that is purely coincidental and is not prear- the corporation sold the assets to the distributeerectly or indirectly own more than 50% of ranged. at fair market value.the capital interests or profits interests in In certain cases in which the distributee is a

Property received from a related person. If,both partnerships. corporation in control of the distributing corpora-in a purchase or exchange, you received prop- tion, the distribution may not be taxable. For13. A person and a partnership if the person erty from a related person who had a loss that more information, see Internal Revenue Codedirectly or indirectly owns more than 50% was not allowable and you later sell or exchange section 332 and its regulations.of the capital interest or profits interest in the property at a gain, you recognize the gain

the partnership. Allocation of consideration paid for a busi-only to the extent it is more than the loss previ-ness. The sale of a trade or business for aously disallowed to the related person. This ruleIf a sale or exchange is between any of theselump sum is considered a sale of each individualapplies only to the original transferee.related persons and involves the lump-sum saleasset rather than of a single asset. Except forof a number of blocks of stock or pieces ofassets exchanged under any nontaxable ex-Example 1. Your brother sold stock to youproperty, the gain or loss must be figured sepa-change rules, both the buyer and seller of afor $7,600. His cost basis was $10,000. His lossrately for each block of stock or piece of prop-business must use the residual method (ex-of $2,400 was not deductible. You later sell theerty. The gain on each item is taxable. The lossplained later) to allocate the consideration tosame stock to an unrelated party for $10,500,on any item is nondeductible. Gains from theeach business asset transferred. This methodrealizing a gain of $2,900 ($10,500 − $7,600).sales of any of these items may not be offset bydetermines gain or loss from the transfer of eachYour recognized gain is only $500, the gain thatlosses on the sales of any of the other items.asset and how much of the consideration is foris more than the $2,400 loss not allowed to yourgoodwill and certain other intangible property. Itbrother.Partnership interests. The nondeductiblealso determines the buyer’s basis in the busi-loss rule does not apply to a sale or exchange ofness assets.Example 2. Assume the same facts as inan interest in the partnership between the re-

Example 1, except that you sell the stock forlated persons described in (12) or (13) above. Consideration. The buyer’s consideration$6,900 instead of $10,500. Your recognized loss is the cost of the assets acquired. The seller’s

Controlled groups. Losses on transactions is only $700 ($7,600 − $6,900). You cannot consideration is the amount realized (moneybetween members of the same controlled group deduct the loss not allowed to your brother. plus the fair market value of property received)described in (3) earlier are deferred rather than from the sale of assets.denied.

Residual method. The residual methodFor more information, see section 267(f) ofmust be used for any transfer of a group ofthe Internal Revenue Code. Other Dispositionsassets that constitutes a trade or business and

Ownership of stock or partnership interests. for which the buyer’s basis is determined only byThis section discusses rules for determining theIn determining whether an individual directly or the amount paid for the assets. This applies totreatment of gain or loss from various disposi-indirectly owns any of the outstanding stock of a both direct and indirect transfers, such as thetions of property.corporation or an interest in a partnership for a sale of a business or the sale of a partnershiploss on a sale or exchange, the following rules interest in which the basis of the buyer’s share ofSale of a Businessapply. the partnership assets is adjusted for the

amount paid under section 743(b) of the InternalThe sale of a business usually is not a sale of1. Stock or a partnership interest directly or Revenue Code. Section 743(b) applies if a part-one asset. Instead, all the assets of the businessindirectly owned by or for a corporation, nership has an election in effect under sectionare sold. Generally, when this occurs, each as-partnership, estate, or trust is considered 754 of the Internal Revenue Code.set is treated as being sold separately for deter-owned proportionately by or for its share- A group of assets constitutes a trade or busi-mining the treatment of gain or loss.holders, partners, or beneficiaries. (How- ness if either of the following applies.A business usually has many assets. Whenever, for a partnership interest owned by orsold, these assets must be classified as capital • Goodwill or going concern value could,for a C corporation, this applies only toassets, depreciable property used in the busi- under any circumstances, attach to them.shareholders who directly or indirectly ownness, real property used in the business, or5% or more in value of the stock of the • The use of the assets would constitute anproperty held for sale to customers, such ascorporation.) active trade or business under section 355inventory or stock in trade. The gain or loss on

of the Internal Revenue Code.2. An individual is considered as owning the each asset is figured separately. The sale ofstock or partnership interest directly or incapital assets results in capital gain or loss. The The residual method provides for the considera-directly owned by or for his or her family. sale of real property or depreciable property tion to be reduced first by the cash and generalFamily includes only brothers, sisters, used in the business and held longer than 1 year deposit accounts (including checking and sav-half-brothers, half-sisters, spouse, ances- results in gain or loss from a section 1231 trans- ings accounts but excluding certificates of de-tors, and lineal descendants. action (discussed in chapter 3). The sale of posit). The consideration remaining after this

inventory results in ordinary income or loss. reduction must be allocated among the various3. An individual owning (other than by apply-business assets in a certain order.ing (2)) any stock in a corporation is con-

Partnership interests. An interest in a part-sidered to own the stock directly or For asset acquisitions occurring after Marchnership or joint venture is treated as a capitalindirectly owned by or for his or her part- 15, 2001, make the allocation among the follow-asset when sold. The part of any gain or lossner. ing assets in proportion to (but not more than)from unrealized receivables or inventory itemstheir fair market value on the purchase date in4. For purposes of applying (1), (2), or (3), will be treated as ordinary gain or loss. For morethe following order.stock or a partnership interest construc- information, see Disposition of Partner’s Interest

tively owned by a person under (1) is in Publication 541. 1. Certificates of deposit, U.S. Governmenttreated as actually owned by that person.securities, foreign currency, and activelyBut stock or a partnership interest con- Corporation interests. Your interest in a cor-traded personal property, including stockstructively owned by an individual under poration is represented by stock certificates.and securities.(2) or (3) is not treated as owned by the When you sell these certificates, you usually

individual for reapplying either (2) or (3) to realize capital gain or loss. For information on 2. Accounts receivable, other debt instru-make another person the constructive the sale of stock, see chapter 4 in Publication ments, and assets that you mark to marketowner of that stock or partnership interest. 550. at least annually for federal income tax




purposes. However, see section and cannot be depreciated. Gain or loss on controlled businesses are treated as a single1.338-6(b)(2)(iii) of the regulations for ex- dispositions of other intangible property is ordi- entity. For example, a corporation cannot deductceptions that apply to debt instruments is- nary or capital depending on whether the prop- a loss on the sale of a section 197 intangible if,sued by persons related to a target erty is a capital asset or a noncapital asset. after the sale, a member of the same controlledcorporation, contingent debt instruments, group retains other section 197 intangibles ac-The following discussions explain specialand debt instruments convertible into stock quired in the same transaction as the intangiblerules that apply to certain dispositions of intangi-or other property. sold.ble property.

3. Property of a kind that would properly be Anti-churning rules. Anti-churning rulesincluded in inventory if on hand at the end prevent a taxpayer from converting section 197Section 197 Intangiblesof the tax year or property held by the intangibles that do not qualify for amortizationtaxpayer primarily for sale to customers in into property that would qualify for amortization.Section 197 intangibles are certain intangiblethe ordinary course of business. However, these rules do not apply to part of theassets acquired after August 10, 1993 (after July

basis of property acquired by certain related4. All other assets except section 197 in- 25, 1991, if chosen), and held in connection withpersons if the transferor chooses to do both thetangibles. the conduct of a trade or business or an activityfollowing.entered into for profit whose costs are amortized5. Section 197 intangibles (other than good-

over 15 years. They include the following as-will and going concern value). • Recognize gain on the transfer of thesets. property.6. Goodwill and going concern value

• Goodwill.(whether the goodwill or going concern • Pay income tax on the gain at the highestvalue qualifies as a section 197 intangible). tax rate.• Going concern value.

If an asset described in (1) through (6) is includi- • Workforce in place. If the transferor is a partnership or S corpora-ble in more than one category, include it in thetion, the partnership or S corporation (not the• Business books and records, operatinglower number category. For example, if an assetpartners or shareholders) can make the choice.systems, and other information bases.is described in both (4) and (6), include it in (4).But each partner or shareholder must pay the• Patents, copyrights, formulas, processes, tax on his or her share of gain.Example. The total paid in the January 10, designs, patterns, know how, formats, and

To make the choice, you, as the transferor,2004, sale of the assets of Company SKB issimilar items.$21,000. No cash or deposit accounts or similar must attach a statement containing certain infor-

accounts were sold. The company’s U.S. Gov- • Customer-based intangibles. mation to your income tax return for the year ofernment securities sold had a fair market value the transfer. You must file the tax return by the• Supplier-based intangibles.of $3,200. The only other asset transferred due date (including extensions). You must also

• Licenses, permits, and other rights(other than goodwill and going concern value) notify the transferee of the choice in writing bywas inventory with a fair market value of granted by a governmental unit. the due date of the return.$15,000. Of the $21,000 paid for the assets of If you timely filed your return without making• Covenants not to compete entered into inCompany SKB, $3,200 is allocated to U.S. Gov- the choice, you can make the choice by filing anconnection with the acquisition of a busi-ernment securities, $15,000 to inventory assets, amended return within 6 months after the dueness.and the remaining $2,800 to goodwill and going date of the return (excluding extensions). Attachconcern value. • Franchises, trademarks, and trade names. the statement to the amended return and write

“Filed under section 301.9100-2” at the top ofAgreement. The buyer and seller may enter For more information, see chapter 9 of Publica-the statement. File the amended return at theinto a written agreement as to the allocation of tion 535.same address the original return was filed.any consideration or the fair market value of any

of the assets. This agreement is binding on both Dispositions. The following rules apply to dis- For more information about making theparties unless the IRS determines the amounts positions of section 197 intangibles. choice, see section 1.197-2(h)(9) of the regula-are not appropriate. tions. For information about reporting the tax onCovenant not to compete. A covenant not

your income tax return, see the instructions forReporting requirement. Both the buyer to compete (or similar arrangement) that is aForm 4797.and seller involved in the sale of business assets section 197 intangible cannot be treated as dis-

must report to the IRS the allocation of the sales posed of or worthless before you have disposedprice among section 197 intangibles and the of your entire interest in the trade or business for Patentsother business assets. Use Form 8594 to pro- which the covenant was entered into. Membersvide this information. The buyer and seller of the same controlled group of corporations and The transfer of a patent by an individual isshould each attach Form 8594 to their federal commonly controlled businesses are treated as treated as a sale or exchange of a capital assetincome tax return for the year in which the sale a single entity in determining whether a member held longer than 1 year. This applies even if theoccurred. has disposed of its entire interest in a trade or payments for the patent are made periodically

business. during the transferee’s use or are contingent onDispositions of the productivity, use, or disposition of the patent.Nondeductible loss. You cannot deduct aIntangible Property For information on the treatment of gain or lossloss from the disposition or worthlessness of aon the transfer of capital assets, see chapter 4.section 197 intangible you acquired in the sameIntangible property is any personal property that This treatment applies to your transfer of atransaction (or series of related transactions) ashas value but cannot be seen or touched. It patent if you meet all the following conditions.another section 197 intangible you still hold.includes such items as patents, copyrights, and

Instead, you must increase the adjusted basis ofthe goodwill value of a business. • You are the holder of the patent.your retained section 197 intangible by the non-Gain or loss on the sale or exchange of • You transfer the patent other than by gift,deductible loss. If you retain more than oneamortizable or depreciable intangible property inheritance, or devise.section 197 intangible, increase eachheld longer than 1 year (other than an amountintangible’s adjusted basis. Figure the increase • You transfer all substantial rights to therecaptured as ordinary income) is a sectionby multiplying the nondeductible loss by a frac- patent or an undivided interest in all such1231 gain or loss. The treatment of section 1231tion, the numerator (top number) of which is thegain or loss and the recapture of amortization rights.retained intangible’s adjusted basis on the dateand depreciation as ordinary income are ex- • You do not transfer the patent to a relatedof the loss and the denominator (bottom num-plained in chapter 3. See chapter 9 of Publica-

person.ber) of which is the total adjusted basis of alltion 535, Business Expenses, for information onretained intangibles on the date of the loss.amortizable intangible property and chapter 1 of

In applying this rule, members of the same Holder. You are the holder of a patent if youPublication 946, How To Depreciate Property,controlled group of corporations and commonly are either of the following.for information on intangible property that can

Page 22 Chapter 2 Ordinary or Capital Gain or Loss



ordinary royalty income rather than an amount exchange occurs that gain or loss is realized.• The individual whose effort created therealized from a sale or exchange. But if you owned or had a contractual right to cutpatent property and who qualifies as the

timber, you can choose to treat the cutting ofA significant power, right, or continuing inter-original and first inventor.timber as a section 1231 transaction in the yearest in a franchise, trademark, or trade name

• The individual who bought an interest in the timber is cut. Even though the cut timber isincludes, but is not limited to, the following rightsthe patent from the inventor before the innot actually sold or exchanged, you report yourin the transferred interest.vention was tested and operated success- gain or loss on the cutting for the year the timber• A right to disapprove any assignment offully under operating conditions and who is is cut. Any later sale results in ordinary business

the interest, or any part of it.neither related to, nor the employer of, the income or loss. See Example, later.inventor. • A right to end the agreement at will. To choose this treatment, you must:

• A right to set standards of quality for prod- • Own, or hold a contractual right to cut, theAll substantial rights. All substantial rights to ucts used or sold, or for services provided, timber for a period of more than 1 yearpatent property are all rights that have value and for the equipment and facilities used before it is cut, andwhen they are transferred. A security interest to promote such products or services.

• Cut the timber for sale or for use in your(such as a lien), or a reservation calling for • A right to make the recipient sell or adver- trade or business.forfeiture for nonperformance, is not treated as atise only your products or services.substantial right for these rules and may be kept

Making the choice. You make the choiceby you as the holder of the patent. • A right to make the recipient buy moston your return for the year the cutting takesAll substantial rights to a patent are not trans- supplies and equipment from you.place by including in income the gain or loss onferred if any of the following apply to the transfer. • A right to receive payments based on the the cutting and including a computation of the

• The rights are limited geographically within productivity, use, or disposition of the gain or loss. You do not have to make the choicea country. transferred item of interest if those pay- in the first year you cut timber. You can make it

ments are a substantial part of the transfer in any year to which the choice would apply. If• The rights are limited to a period less thanagreement. the timber is partnership property, the choice isthe remaining life of the patent.

made on the partnership return. This choice• The rights are limited to fields of use within cannot be made on an amended return.Subdivision of Landtrades or industries and are less than all Once you have made the choice, it remains

the rights that exist and have value at the in effect for all later years unless you cancel it.If you own a tract of land and, to sell or exchangetime of the transfer.it, you subdivide it into individual lots or parcels, An election to treat the cutting of timber• The rights are less than all the claims or the gain normally is ordinary income. However, as a sale or exchange may be revoked

inventions covered by the patent that exist you may receive capital gain treatment on at without IRS approval if the election wasTIP

and have value at the time of the transfer. least part of the proceeds provided you meet made before October 23, 2004, for a tax yearcertain requirements. See section 1237 of the ending after October 22, 2004. Currently, IRSInternal Revenue Code. approval is required only if an election is madeRelated persons. This tax treatment does not

for a tax year ending before October 23, 2004.apply if the transfer is directly or indirectly be-Timbertween you and a related person as defined ear-

Gain or loss. Your gain or loss on the cut-lier under Nondeductible Loss, with the followingting of standing timber is the difference betweenStanding timber held as investment property is achanges. its adjusted basis for depletion and its fair mar-capital asset. Gain or loss from its sale is re-ket value on the first day of your tax year in1. Members of your family include your ported as a capital gain or loss on Schedule Dwhich it is cut.spouse, ancestors, and lineal descend- (Form 1040). If you held the timber primarily for

ants, but not your brothers, sisters, sale to customers, it is not a capital asset. Gain Your adjusted basis for depletion of cut tim-half-brothers, or half-sisters. or loss on its sale is ordinary business income or ber is based on the number of units (feet board

loss. It is reported in the gross receipts or sales measure, log scale, or other units) of timber cut2. Substitute “25% or more” ownership forand cost of goods sold items of your return. during the tax year and considered to be sold or“more than 50%” in that listing.

Farmers who cut timber on their land and sell exchanged. Your adjusted basis for depletion isIf you fit within the definition of a related it as logs, firewood, or pulpwood usually have no also based on the depletion unit of timber in the

person independent of family status, the cost or other basis for that timber. These sales account used for the cut timber, and should bebrother-sister exception in (1), earlier, does not constitute a very minor part of their farm busi- figured in the same manner as shown in sectionapply. For example, a transfer between a nesses. In these cases, amounts realized from 611 of the Internal Revenue Code and regula-brother and a sister as beneficiary and fiduciary such sales, and the expenses of cutting, haul- tion section 1.611-3.of the same trust is a transfer between related ing, etc., are ordinary farm income and ex- Timber depletion is discussed in chapter 10persons. The brother-sister exception does not penses reported on Schedule F (Form 1040), in Publication 535.apply because the trust relationship is indepen- Profit or Loss From Farming.dent of family status. Different rules apply if you owned the timber Example. In April 2004, you had owned

longer than 1 year and choose to either: 4,000 MBF (1,000 board feet) of standing timberlonger than 1 year. It had an adjusted basis for• Treat timber cutting as a sale or ex-Franchise, Trademark, depletion of $40 per MBF. You are a calendarchange, oror Trade Name year taxpayer. On January 1, 2004, the timber

• Enter into a cutting contract. had a fair market value (FMV) of $350 per MBF.If you transfer or renew a franchise, trademark, It was cut in April for sale. On your 2004 taxUnder the rules discussed below, disposition ofor trade name for a price contingent on its pro- return, you choose to treat the cutting of thethe timber is treated as a section 1231 transac-ductivity, use, or disposition, the amount you timber as a sale or exchange. You report thetion. See chapter 3. Gain or loss is reported onreceive generally is treated as an amount real- difference between the fair market value andForm 4797.ized from the sale of a noncapital asset. A your adjusted basis for depletion as a gain. Thisfranchise includes an agreement that gives one amount is reported on Form 4797 along withChristmas trees. Evergreen trees, such asof the parties the right to distribute, sell, or pro- your other section 1231 gains and losses toChristmas trees, that are more than 6 years oldvide goods, services, or facilities within a speci- figure whether it is treated as capital gain or aswhen severed from their roots and sold for orna-fied area. ordinary gain. You figure your gain as follows.mental purposes are included in the term timber.Significant power, right, or continuing inter- They qualify for both rules discussed below.

FMV of timber January 1, 2004 $1,400,000est. If you keep any significant power, right, orMinus: Adjusted basis forcontinuing interest in the subject matter of a Choice to treat cutting as a sale or exchange.depletion . . . . . . . . . . . . . . . . 160,000franchise, trademark, or trade name that you Under the general rule, the cutting of timber

transfer or renew, the amount you receive is results in no gain or loss. It is not until a sale or Section 1231 gain . . . . . . . . . . $1,240,000




The fair market value becomes your basis in the Precious Metals and • An applicable straddle (generally, any setcut timber and a later sale of the cut timber Stones, Stamps, and Coins of offsetting positions with respect to per-including any by-product or tree tops will result in sonal property, including stock).ordinary business income or loss. Gold, silver, gems, stamps, coins, etc., are capi-

• A transaction in which you acquire prop-tal assets except when they are held for sale byerty and, at or about the same time, youCutting contract. You must treat the disposal a dealer. Any gain or loss from their sale orcontract to sell the same or substantiallyof standing timber under a cutting contract as a exchange generally is a capital gain or loss. Ifidentical property at a specified price.section 1231 transaction if all the following apply you are a dealer, the amount received from the

sale is ordinary business income.to you. • Any other transaction that is marketed andsold as producing capital gain from a• You are the owner of the timber. Coal and Iron Ore transaction in which substantially all of

• You held the timber longer than 1 year your expected return is due to the timeYou must treat the disposal of coal (includingbefore its disposal. value of your net investment.lignite) or iron ore mined in the United States as• You kept an economic interest in the tim- a section 1231 transaction if both the following For more information, see chapter 4 of Publi-ber. apply to you. cation 550.

• You owned the coal or iron ore longer thanThe difference between the amount realized1 year before its disposal.from the disposal of the timber and its adjusted

basis for depletion is treated as gain or loss on • You kept an economic interest in the coalits sale. Include this amount on Form 4797 along or iron ore.with your other section 1231 gains or losses to

For this rule, the date the coal or iron ore isfigure whether it is treated as capital or ordinary 3.mined is considered the date of its disposal.gain or loss.Your gain or loss is the difference between theDate of disposal. The date of disposal is

amount realized from disposal of the coal or ironthe date the timber is cut. However, if you re-ore and the adjusted basis you use to figure cost Ordinary orceive payment under the contract before the depletion (increased by certain expenses not

timber is cut, you can choose to treat the date of allowed as deductions for the tax year). Thispayment as the date of disposal. Capital Gainamount is included on Form 4797 along with

This choice applies only to figure the holding your other section 1231 gains and losses.period of the timber. It has no effect on the time You are considered an owner if you own or or Loss forfor reporting gain or loss (generally when the sublet an economic interest in the coal or irontimber is sold or exchanged). ore in place. If you own only an option to buy the

coal in place, you do not qualify as an owner. InTo make this choice, attach a statement to Businessaddition, this gain or loss treatment does notthe tax return filed by the due date (includingapply to income realized by an owner who is aextensions) for the year payment is received. Propertyco-adventurer, partner, or principal in the miningThe statement must identify the advance pay-of coal or iron ore.ments subject to the choice and the contract

The expenses of making and administeringunder which they were made.the contract under which the coal or iron ore wasIf you timely filed your return for the year you Introductiondisposed of and the expenses of preserving thereceived payment without making the choice,

When you dispose of business property, youreconomic interest kept under the contract areyou still can make the choice by filing an taxable gain or loss is usually a section 1231not allowed as deductions in figuring taxableamended return within 6 months after the due gain or loss. Its treatment as ordinary or capitalincome. Rather, their total, along with the ad-date for that year’s return (excluding exten- is determined under rules for section 1231 trans-justed depletion basis, is deducted from thesions). Attach the statement to the amended actions.amount received to determine gain. If the total ofreturn and write “Filed under section these expenses plus the adjusted depletion ba- When you dispose of depreciable property301.9100-2” at the top of the statement. File the sis is more than the amount received, the result (section 1245 property or section 1250 property)amended return at the same address the origi- is a loss. at a gain, you may have to recognize all or partnal return was filed.

of the gain as ordinary income under the depre-Special rule. The above treatment does notOwner. The owner of timber is any person ciation recapture rules. Any remaining gain is aapply if you directly or indirectly dispose of thewho owns an interest in it, including a sublessor section 1231 gain.iron ore or coal to any of the following persons.and the holder of a contract to cut the timber.

You own an interest in timber if you have the Topics• A related person whose relationship to youright to cut it for sale on your own account or for would result in the disallowance of a loss This chapter discusses:use in your business. (see Nondeductible Loss under Sales and

Exchanges Between Related Persons, • Section 1231 gains and lossesEconomic interest. You have kept an eco-earlier).nomic interest in standing timber if, under the • Depreciation recapture

cutting contract, the expected return on your • An individual, trust, estate, partnership,association, company, or corporationinvestment is conditioned on the cutting of the

Useful Itemsowned or controlled directly or indirectly bytimber.You may want to see:the same interests that own or control your

business.Tree stumps. Tree stumps are a capital assetPublicationif they are on land held by an investor who is not

in the timber or stump business as a buyer, ❏ 534 Depreciating Property Placed inConversion Transactionsseller, or processor. Gain from the sale of Service Before 1987stumps sold in one lot by such a holder is taxed Recognized gain on the disposition or termina-

❏ 537 Installment Salesas a capital gain. However, tree stumps held by tion of any position held as part of certain con-timber operators after the saleable standing tim- version transactions is treated as ordinary ❏ 551 Basis of Assetsber was cut and removed from the land are income. This applies if substantially all your ex-

❏ 946 How To Depreciate Propertyconsidered by-products. Gain from the sale of pected return is attributable to the time value ofstumps in lots or tonnage by such operators is ❏ 954 Tax Incentives for Distressedyour net investment (like interest on a loan) andtaxed as ordinary income. the transaction is any of the following. Communities

Page 24 Chapter 3 Ordinary or Capital Gain or Loss for Business Property



Form (and Instructions) ness or a transaction entered into for Example. Ashley, Inc., a graphic arts com-pany, is a calendar year corporation. In 2001, itprofit, such as investment property. It can-

❏ 4797 Sales of Business Property had a net section 1231 loss of $8,000. For taxnot be property held for personal use.years 2003 and 2004, the company has net• Casualties and thefts. The casualty orSee chapter 5 for information about getting section 1231 gains of $5,250 and $4,600, re-

theft must have affected business prop-publications and forms. spectively. In figuring taxable income for 2003,erty, property held for the production of Ashley treated its net section 1231 gain ofrents and royalties, or investment property $5,250 as ordinary income by recapturing(such as notes and bonds). You must $5,250 of its $8,000 net section 1231 loss fromhave held the property longer than 1 year.Section 1231 2001. In 2004 it applies its remaining net sectionHowever, if your casualty or theft losses 1231 loss, $2,750 ($8,000 − $5,250) against itsare more than your casualty or theft gains,Gains and Losses net section 1231 gain, $4,600. For 2004, theneither the gains nor the losses are taken company reports $2,750 as ordinary income andinto account in the section 1231 computa-Section 1231 gains and losses are the taxable $1,850 ($4,600 − $2,750) as long-term capitaltion. For more information on casualtiesgains and losses from section 1231 transac- gain.and thefts, see Publication 547, Casual-tions. Their treatment as ordinary or capital de-ties, Disasters, and Thefts.pends on whether you have a net gain or a net

loss from all your section 1231 transactions.

Property for sale to customers. A sale, ex- DepreciationIf you have a gain from a section 1231change, or involuntary conversion of propertytransaction, first determine whetherheld mainly for sale to customers is not a section Recaptureany of the gain is ordinary incomeCAUTION

!1231 transaction. If you will get back all, orunder the depreciation recapture rules (ex-nearly all, of your investment in the property by If you dispose of depreciable or amortizableplained later). Do not take that gain into accountselling it rather than by using it up in your busi- property at a gain, you may have to treat all oras section 1231 gain.ness, it is property held mainly for sale to cus- part of the gain (even if otherwise nontaxable) astomers. ordinary income.Section 1231 transactions. The following

transactions result in gain or loss subject to To figure any gain that must be re-Example. You manufacture and sell steelsection 1231 treatment. ported as ordinary income, you mustcable, which you deliver on returnable reels thatkeep permanent records of the factsRECORDS• Sales or exchanges of real property or are depreciable property. Customers make de-

necessary to figure the depreciation or amortiza-depreciable personal property. This prop- posits on the reels, which you refund if the reelstion allowed or allowable on your property. Thiserty must be used in a trade or business are returned within a year. If they are not re-includes the date and manner of acquisition,and held longer than 1 year. Generally, turned, you keep each deposit as thecost or other basis, depreciation or amortization,property held for the production of rents or agreed-upon sales price. Most reels are re-and all other adjustments that affect basis.royalties is considered to be used in a turned within the 1-year period. You keep ade-

On property you acquired in a nontaxabletrade or business. Depreciable personal quate records showing depreciation and otherexchange or as a gift, your records also mustproperty includes amortizable section 197 charges to the capitalized cost of the reels.indicate the following information.intangibles (described in chapter 2 under Under these conditions, the reels are not prop-

Other Dispositions). erty held for sale to customers in the ordinarycourse of your business. Any gain or loss result- • Whether the adjusted basis was figured• Sales or exchanges of leaseholds. Theing from their not being returned may be capital using depreciation or amortization youleasehold must be used in a trade or busi-or ordinary, depending on your section 1231 claimed on other property.ness and held longer than 1 year.transactions.

• Whether the adjusted basis was figured• Sales or exchanges of cattle and horses.using depreciation or amortization anotherCopyrights. The sale of a copyright, a liter-The cattle and horses must be held forperson claimed.ary, musical, or artistic composition, or similardraft, breeding, dairy, or sporting purposes

property is not a section 1231 transaction if yourand held for 2 years or longer.personal efforts created the property, or if you Corporate distributions. For information on• Sales or exchanges of other livestock. acquired the property in a way that entitled you property distributed by corporations, see Distri-This livestock does not include poultry. It to the basis of the previous owner whose per- butions to Shareholders in Publication 542, Cor-must be held for draft, breeding, dairy, or sonal efforts created it (for example, if you re- porations.sporting purposes and held for 1 year or ceive the property as a gift). The sale of such

longer. General asset accounts. Different rules ap-property results in ordinary income and gener-ply to dispositions of property you depreciatedally is reported in Part II of Form 4797.• Sales or exchanges of unharvested crops.using a general asset account. For informationThe crop and land must be sold, ex-

Treatment as ordinary or capital. To deter- on these rules, see section 1.168(i)-1(e) of thechanged, or involuntarily converted at themine the treatment of section 1231 gains and regulations.same time and to the same person andlosses, combine all your section 1231 gains andthe land must be held longer than 1 year.losses for the year.The taxpayer cannot keep any right or op- Section 1245 Property

tion to directly or indirectly reacquire the • If you have a net section 1231 loss, it isA gain on the disposition of section 1245 prop-land (other than a right customarily inci- ordinary loss.erty is treated as ordinary income to the extent ofdent to a mortgage or other security trans-

• If you have a net section 1231 gain, it is depreciation allowed or allowable on the prop-action). Growing crops sold with a leaseordinary income up to the amount of your erty. See Gain Treated as Ordinary Income,on the land, though sold to the same per-nonrecaptured section 1231 losses from later.son in the same transaction, are not in-previous years. The rest, if any, iscluded. Any gain recognized that is more than thelong-term capital gain. part that is ordinary income from depreciation is• Cutting of timber or disposal of timber,

a section 1231 gain. See Treatment as ordinarycoal, or iron ore. The cutting or disposal Nonrecaptured section 1231 losses. Your or capital under Section 1231 Gains andmust be treated as a sale, as described in nonrecaptured section 1231 losses are your net Losses, earlier.chapter 2 under Timber and Coal and Iron section 1231 losses for the previous 5 years thatOre. have not been applied against a net section Section 1245 property. Section 1245 prop-

1231 gain by treating the gain as ordinary in-• Condemnations. The condemned property erty includes any property that is or has beencome. These losses are applied against your netmust have been held longer than 1 year. It subject to an allowance for depreciation orsection 1231 gain beginning with the earliestmust be business property or a capital as- amortization and that is any of the followingloss in the 5-year period.set held in connection with a trade or busi- types of property.

Chapter 3 Ordinary or Capital Gain or Loss for Business Property Page 25



e. Section 197 intangibles.Gain Treated as Ordinary Income1. Personal property (either tangible or intan-

f. Childcare facility expenses made beforegible). The gain treated as ordinary income on the sale,1982.exchange, or involuntary conversion of section2. Other tangible property (except buildings

1245 property, including a sale and leaseback g. Franchises, trademarks, and tradeand their structural components) used astransaction, is the lesser of the following names acquired before August 11,any of the following. amounts. 1993.

a. An integral part of manufacturing, pro-1. The depreciation and amortization allowed 5. The section 179 deduction.duction, or extraction, or of furnishing

or allowable on the property.transportation, communications, elec- 6. Deductions for all the following costs.2. The gain realized on the disposition (thetricity, gas, water, or sewage disposal

amount realized from the disposition minusservices. a. Removing barriers to the disabled andthe adjusted basis of the property). the elderly.b. A research facility in any of the activities

A limit on this amount for gain on like-kind ex- b. Tertiary injectant expenses.in (a).changes and involuntary conversions is ex-

c. Depreciable clean-fuel vehicles and re-c. A facility in any of the activities in (a) for plained later.fueling property (minus the amount ofthe bulk storage of fungible commodi- For any other disposition of section 1245 any recaptured deduction).ties. property, ordinary income is the lesser of (1)

d. Environmental cleanup costs.earlier or the amount by which its fair market3. That part of real property (not included in value is more than its adjusted basis. See Gifts

(2)) with an adjusted basis that was re- 7. Any basis reduction for the investmentand Transfers at Death, later.duced by certain amortization deductions credit (minus any basis increase for creditUse Part III of Form 4797 to figure the ordi-(including those for certified pollution con- recapture).nary income part of the gain.trol facilities, childcare facilities, removal of

8. Any basis reduction for the qualified elec-architectural barriers to persons with disa- Depreciation taken on other property or tric vehicle credit (minus any basis in-bilities and the elderly, or reforestation ex- taken by other taxpayers. Depreciation and crease for credit recapture).penses) or a section 179 deduction. amortization include the amounts you claimedon the section 1245 property as well as the4. Single purpose agricultural (livestock) or

Example. You file your returns on a calen-following depreciation and amortizationhorticultural structures.dar year basis. In February 2002, you boughtamounts.

5. Storage facilities (except buildings and and placed in service for 100% use in your• Amounts you claimed on property you ex-their structural components) used in dis- business a light-duty truck (5-year property) thatchanged for, or converted to, your sectiontributing petroleum or any primary product cost $10,000. You used the half-year convention1245 property in a like-kind exchange orof petroleum. and your MACRS deductions for the truck wereinvoluntary conversion. See Caution, be- $2,000 in 2002 and $3,200 in 2003. You did notlow.Buildings and structural components. take the section 179 deduction. You sold the

Section 1245 property does not include build- truck in May 2004 for $7,000. The MACRS de-• Amounts a previous owner of the sectionings and structural components. Do not treat duction in 2004, the year of sale, is $960 (1/2 of1245 property claimed if your basis is de-structures that are essentially items of machin- $1,920). Figure the gain treated as ordinary in-termined with reference to that person’sery or equipment as buildings and structural come as follows.adjusted basis (for example, the donor’scomponents. Also, do not treat as buildings depreciation deductions on property you

1) Amount realized . . . . . . . . . . . . . . $7,000structures that house property used as an inte- received as a gift).2) Cost (February 2002) . . . . $10,000gral part of an activity if the structures’ use is so3) Depreciation allowed orclosely related to the property’s use that the

Simpler rules apply for section 1245 allowable (MACRSstructures can be expected to be replaced whenproperty you acquired after February deductions: $2,000 +the property they initially house is replaced. The

$3,200 + $960) . . . . . . . . 6,16027, 2004. If you use MACRS, you canCAUTION!

fact that the structures are specially designed to 4) Adjusted basis (subtract line 3elect to continue depreciating the property ex-withstand the stress and other demands of the from line 2) . . . . . . . . . . . . . . . . . $3,840changed or involuntarily converted as if theproperty and the fact that the structures cannot 5) Gain realized (subtract line 4transfer had not occurred. The excess basis, ifbe used economically for other purposes indi- from line 1) . . . . . . . . . . . . . . . . . $3,160any, is treated as newly placed in service prop-cate that they are closely related to the use of 6) Gain treated as ordinary incomeerty. For details, see Figuring the Deduction forthe property they house. Structures such as oil (lesser of line 3 or line 5) . . . . . . . $3,160Property Acquired in a Nontaxable Exchange inand gas storage tanks, grain storage bins, silos, chapter 4 of Publication 946.fractionating towers, blast furnaces, basic oxy- Depreciation on other tangible property.gen furnaces, coke ovens, brick kilns, and coal You must take into account depreciation duringDepreciation and amortization. Deprecia-tipples are not treated as buildings. periods when the property was not used as antion and amortization that must be recaptured as

integral part of an activity or did not constitute aFacility for bulk storage of fungible com- ordinary income include (but are not limited to)research or storage facility, as described earlierthe following items.modities. This term includes oil or gas storageunder Section 1245 property.tanks and grain storage bins. Bulk storage

For example, if depreciation deductions1. Ordinary depreciation deductions.means the storage of a commodity in a largetaken on certain storage facilities amounted tomass before it is used. For example, if a facility 2. The 30% special depreciation allowance $10,000, of which $6,000 is from the periodsis used to store oranges that have been sorted for property acquired after September 10, before their use in a prescribed business activ-and boxed, it is not used for bulk storage. To be 2001. ity, you must use the entire $10,000 in determin-fungible, a commodity must be such that oneing ordinary income from depreciation.3. The 50% special depreciation allowancepart may be used in place of another.

for property acquired after May 5, 2003.Stored materials that vary in composition, Depreciation allowed or allowable. The

4. Amortization deductions for all the follow-size, and weight are not fungible. Materials are greater of the depreciation allowed or allowableing costs.not fungible if one part cannot be used in place is generally the amount to use in figuring the part

of another part and the materials cannot be of gain to report as ordinary income. If, in priora. Acquiring a lease.estimated and replaced by simple reference to years, you have consistently taken proper de-

weight, measure, and number. For example, the ductions under one method, the amount allowedb. Lessee improvements.storage of different grades and forms of alumi- for your prior years will not be increased even

c. Pollution control facilities.num scrap is not storage of fungible commodi- though a greater amount would have been al-ties. d. Reforestation expenses. lowed under another proper method. If you did




not take any deduction at all for depreciation, You will not have additional depreciation if amount allowable, the lesser figure will be theany of the following conditions apply to the prop- depreciation adjustment for figuring additionalyour adjustments to basis for depreciation allow-erty disposed of. depreciation.able are figured by using the straight line

method. • You figured depreciation for the property Retired or demolished property. The adjust-This treatment applies only when figuring using the straight line method or any other ments reflected in adjusted basis generally do

what part of gain is treated as ordinary income method that does not result in depreciation not include deductions for depreciation on re-under the rules for section 1245 depreciation that is more than the amount figured by tired or demolished parts of section 1250 prop-recapture. the straight line method; you held the erty unless these deductions are reflected in the

property longer than 1 year; and, if the basis of replacement property that is sectionMultiple asset accounts. In figuring ordinary property was qualified New York Liberty 1250 property.income from depreciation, you can treat any Zone property, you made a timely electionnumber of units of section 1245 property in a Example. A wing of your building is totallynot to claim the 30% or 50% special de-single depreciation account as one item if the destroyed by fire. The depreciation adjustmentspreciation allowance. In addition, if thetotal ordinary income from depreciation figured figured in the adjusted basis of the building afterproperty was in a renewal community, youby using this method is not less than it would be the wing is destroyed do not include any deduc-must not have elected to claim a commer-if depreciation on each unit were figured sepa- tions for depreciation on the destroyed wingcial revitalization deduction as figuredrately. unless it is replaced and the adjustments forunder section 1400I of the Internal Reve-

depreciation on it are reflected in the basis of thenue Code.Example. In one transaction you sold 50 replacement property.• The property was residential low-incomemachines, 25 trucks, and certain other property

Figuring straight line depreciation. Therental property you held for 162/3 years orthat is not section 1245 property. All of the de-useful life and salvage value you would havelonger. For low-income rental housing onpreciation was recorded in a single depreciationused to figure straight line depreciation are thewhich the special 60-month depreciationaccount. After dividing the total received amongsame as those used under the depreciationfor rehabilitation expenses was allowed,the various assets sold, you figured that eachmethod you actually used. If you did not use athe 162/3 years start when the rehabilitatedunit of section 1245 property was sold at a gain.useful life under the depreciation method actu-property is placed in service.You can figure the ordinary income from depre-ally used (such as with the units-of-productionciation as if the 50 machines and 25 trucks were • You chose the alternate ACRS method for method) or if you did not take salvage value intoone item. the property, which was a type of 15-, 18-, account (such as with the declining balanceHowever, if 5 of the trucks had been sold at a or 19-year real property covered by the method), the useful life or salvage value forloss, only the 50 machines and 20 of the trucks section 1250 rules. figuring what would have been the straight linecould be treated as one item in determining thedepreciation is the useful life and salvage value• The property was residential rental prop-ordinary income from depreciation.you would have used under the straight lineerty or nonresidential real property placed

Normal retirement. The normal retirement method.in service after 1986 (or after July 31,of section 1245 property in multiple asset ac- Salvage value and useful life are not used for1986, if the choice to use MACRS wascounts does not require recognition of gain as the ACRS method of depreciation. Figuremade); you held it longer than 1 year; and,ordinary income from depreciation if your straight line depreciation for ACRS real propertyif the property was qualified New York Lib-method of accounting for asset retirements does by using its 15-, 18-, or 19-year recovery perioderty Zone property, you made a timelynot require recognition of that gain. as the property’s useful life.election not to claim the 30% or the 50%

The straight line method is applied withoutspecial depreciation allowance. Theseany basis reduction for the investment credit.properties are depreciated using theSection 1250 Property

straight line method. In addition, if the Property held by lessee. If a lessee makesGain on the disposition of section 1250 property property was in a renewal community, you a leasehold improvement, the lease period foris treated as ordinary income to the extent of must not have elected to claim a commer- figuring what would have been the straight lineadditional depreciation allowed or allowable on cial revitalization deduction as figured depreciation adjustments includes all renewalthe property. To determine the additional depre- under section 1400I of the Internal Reve- periods. This inclusion of the renewal periods

nue Code.ciation on section 1250 property, see Additional cannot extend the lease period taken into ac-Depreciation, later. count to a period that is longer than the remain-

Depreciation taken by other taxpayers or on ing useful life of the improvement. The same ruleSection 1250 property defined. This in- other property. Additional depreciation in- applies to the cost of acquiring a lease.cludes all real property that is subject to an cludes all depreciation adjustments to the basis The term renewal period means any periodallowance for depreciation and that is not and of section 1250 property whether allowed to you for which the lease may be renewed, extended,never has been section 1245 property. It in- or another person (as carryover basis property). or continued under an option exercisable by thecludes a leasehold of land or section 1250 prop-lessee. However, the inclusion of renewal peri-erty subject to an allowance for depreciation. A Example. Larry Johnson gives his son sec- ods cannot extend the lease by more thanfee simple interest in land is not included be- tion 1250 property on which he took $2,000 in two-thirds of the period that was the basis oncause it is not depreciable. depreciation deductions, of which $500 is addi- which the actual depreciation adjustments were

If your section 1250 property becomes sec- tional depreciation. Immediately after the gift, allowed.tion 1245 property because you change its use, the son’s adjusted basis in the property is the

Rehabilitation expenses. A part of the spe-you can never again treat it as section 1250 same as his father’s and reflects the $500 addi-cial 60-month depreciation adjustment allowedproperty. tional depreciation. On January 1 of the nextfor rehabilitation expenses incurred before 1987year, after taking depreciation deductions ofin connection with low-income rental housing is$1,000 on the property, of which $200 is addi-additional depreciation. The additional deprecia-Additional Depreciation tional depreciation, the son sells the property. Attion is the special depreciation adjustments thatthe time of sale, the additional depreciation isIf you hold section 1250 property longer than 1 are more than the adjustments that would have$700 ($500 allowed the father plus $200 allowedyear, the additional depreciation is the actual resulted if the straight line method, normal use-the son).depreciation adjustments that are more than the ful life, and salvage value had been used.

depreciation figured using the straight line Depreciation allowed or allowable. Themethod. For a list of items treated as deprecia- greater of depreciation allowed or allowable (to Example. On January 7, 2001, Fred Plums,tion adjustments, see Depreciation and amorti- any person who held the property if the depreci- a calendar year taxpayer, sold real property inzation under Gain Treated as Ordinary Income, ation was used in figuring its adjusted basis in which the entire basis was from rehabilitationearlier. your hands) generally is the amount to use in expenses of $40,000 incurred in 1985. The

If you hold section 1250 property for 1 year or figuring the part of the gain to be reported as property was placed in service on January 3,less, all the depreciation is additional deprecia- ordinary income. If you can show that the deduc- 1986. Under the special depreciation provisionstion. tion allowed for any tax year was less than the for rehabilitation expenses, the property was




depreciated under the straight line method using receive subsidies under section 8 of the Low-Income Housinga useful life of 60 months (5 years) and no United States Housing Act of 1937, as With Two or More Elementssalvage value. If Fred had used the regular amended, or under provisions of state or

If you dispose of low-income housing propertystraight line method, he would have used a sal- local laws that authorize similar subsidiesthat has two or more separate elements, thevage value of $4,000 and a useful life of 15 for low-income families.applicable percentage used to figure ordinaryyears, and would have had a depreciable basis • Housing financed or assisted by direct income because of additional depreciation mayof $36,000. Depreciation under the straight line

loan or insured under Title V of the Hous- be different for each element. The gain to bemethod would have been $2,400 each year (1/15

ing Act of 1949. reported as ordinary income is the sum of the× $36,000). On January 1, 2001, the additionalordinary income figured for each element.depreciation for the property was $4,000, fig-

The applicable percentage for low-incomeured as follows. The following are the types of separate ele-housing is 100% minus 1% for each full month ments.the property was held over 100 full months. IfDepreciation Straight Additional

• A separate improvement (defined later).Line you have held low-income housing at least 16Claimed DepreciationDepreciation years and 8 months, the percentage is zero and • The basic section 1250 property plus im-

no ordinary income will result from its disposi- provements not qualifying as separate im-1986 8,000 2,400 5,600 tion. provements.1987 8,000 2,400 5,600

Foreclosure. If low-income housing is dis-1988 8,000 2,400 5,600 • The units placed in service at different1989 8,000 2,400 5,600 posed of because of foreclosure or similar pro- times before all the section 1250 property1990 8,000 2,400 5,600 ceedings, the monthly applicable percentage is finished. For example, this happens1991 2,400 (2,400) reduction is figured as if you disposed of the when a taxpayer builds an apartment1992 2,400 (2,400) property on the starting date of the proceedings. building of 100 units and places 30 units in1993 2,400 (2,400) service (available for renting) on January1994 2,400 (2,400) Example. On June 1, 1992, you acquired 4, 2003, 50 on July 18, 2003, and the1995 2,400 (2,400) low-income housing property. On April 3, 2003 remaining 20 on January 18, 2004. As a1996 2,400 (2,400)

result, the apartment house consists of(130 months after the property was acquired),1997 2,400 (2,400)three separate elements.foreclosure proceedings were started on the1998 2,400 (2,400)

property and on December 3, 2004 (150 months1999 2,400 (2,400)after the property was acquired), the property2000 2,400 (2,400) The 36-month test for separate improve-was disposed of as a result of the foreclosureTotal $40,000 $36,000 $4,000 ments. A separate improvement is any im-proceedings. The property qualifies for a re- provement (qualifying under The 1-year test,duced applicable percentage because it was below) added to the capital account of the prop-held more than 100 full months. The applicable erty, but only if the total of the improvementsApplicable Percentagepercentage reduction is 30% (130 months minus during the 36-month period ending on the last

day of any tax year is more than the greatest ofThe applicable percentage used to figure the 100 months) rather than 50% (150 months mi-the following amounts. ordinary income because of additional deprecia- nus 100 months) because it does not apply after

tion depends on whether the real property you April 3, 2003, the starting date of the foreclosure1. One-fourth of the adjusted basis of thedisposed of is nonresidential real property, resi- proceedings. Therefore, 70% of the additional

property at the start of the first day of thedential rental property, or low-income housing. depreciation is treated as ordinary income.36-month period, or the first day of theThe percentages for these types of real property

Holding period. The holding period used to holding period of the property, whichever isare as follows.figure the applicable percentage for low-income later.housing generally starts on the day after youNonresidential real property. For real prop-

2. One-tenth of the unadjusted basis (ad-erty that is not residential rental property, the acquired it. For example, if you bought low-in-justed basis plus depreciation and amorti-applicable percentage for periods after 1969 is come housing on January 1, 1988, the holdingzation adjustments) of the property at the100%. For periods before 1970, the percentage period starts on January 2, 1988. If you sold it on start of the period determined in (1).is zero and no ordinary income because of addi- January 2, 2004, the holding period is exactly

tional depreciation before 1970 will result from 3. $5,000.192 full months. The applicable percentage forits disposition. additional depreciation is 8%, or 100% minus

The 1-year test. An addition to the capital1% for each full month the property was heldResidential rental property. For residential account for any tax year (including a short taxover 100 full months.rental property (80% or more of the gross in- year) is treated as an improvement only if theHolding period for constructed, recon-come is from dwelling units) other than low-in- sum of all additions for the year is more than the

come housing, the applicable percentage for structed, or erected property. The holding greater of $2,000 or 1% of the unadjusted basisperiods after 1975 is 100%. The percentage for period used to figure the applicable percentage of the property. The unadjusted basis is figuredperiods before 1976 is zero. Therefore, no ordi- for low-income housing you constructed, recon- as of the start of that tax year or the holdingnary income because of additional depreciation structed, or erected starts on the first day of the period of the property, whichever is later. Inbefore 1976 will result from a disposition of resi- month it is placed in service in a trade or busi- applying the 36-month test, improvements indential rental property. ness, in an activity for the production of income, any one of the 3 years are omitted entirely if the

or in a personal activity. total improvements in that year do not qualifyLow-income housing. Low-income housingunder the 1-year test.Property acquired by gift or received in aincludes all the following types of residential

tax-free transfer. For low-income housingrental property. Example. The unadjusted basis of a calen-you acquired by gift or in a tax-free transfer the dar year taxpayer’s property was $300,000 on• Federally assisted housing projects if thebasis of which is figured by reference to the January 1 of this year. During the year, themortgage is insured under sectionbasis in the hands of the transferor, the holding taxpayer made improvements A, B, and C,221(d)(3) or 236 of the National Housingperiod for the applicable percentage includes which cost $1,000, $600, and $700, respec-Act or housing financed or assisted by di-the holding period of the transferor. tively. The sum of the improvements, $2,300, isrect loan or tax abatement under similar

If the adjusted basis of the property in your less than 1% of the unadjusted basis ($3,000),provisions of state or local laws.hands just after acquiring it is more than its so the improvements do not satisfy the 1-year• Low-income rental housing for which a de- adjusted basis to the transferor just before trans- test and are not treated as improvements for the

preciation deduction for rehabilitation ex- ferring it, the holding period of the difference is 36-month test. However, if improvement C hadpenses was allowed. figured as if it were a separate improvement. cost $1,500, the sum of these improvements

See Low-Income Housing With Two or More• Low-income rental housing held for occu- would have been $3,100. Then, it would bepancy by families or individuals eligible to Elements, next. necessary to apply the 36-month test to figure if




the improvements must be treated as separate ments’ additional depreciation after 1975 to Use Part III, Form 4797, to figure the ordinaryimprovements. income part of the gain.determine the percentage used in Step 2.

Step 2. Multiply the percentage figured inAddition to the capital account. Any addi- Corporations. Corporations, other than S cor-Step 1 by the lesser of the additional deprecia-tion to the capital account made after the initial porations, have an additional amount to recog-tion after 1975 for the entire property or the gainacquisition or completion of the property by you nize as ordinary income on the sale or otherfrom disposition of the entire property (the differ-or any person who held the property during a disposition of section 1250 property. The addi-ence between the fair market value or amountperiod included in your holding period is to be tional amount treated as ordinary income is 20%realized and the adjusted basis).considered when figuring the total amount of of the excess of the amount that would haveStep 3. Multiply the result in Step 2 by theseparate improvements. been ordinary income if the property were sec-

applicable percentage for the element.The addition to the capital account of depre- tion 1245 property over the amount treated asciable real property is the gross addition not ordinary income under section 1250. Report thisExample. You sold at a gain of $25,000reduced by amounts attributable to replaced additional ordinary income on Form 4797, Partlow-income housing property subject to the ordi-property. For example, if a roof with an adjusted III, line 26 (f).nary income rules of section 1250. The propertybasis of $20,000 is replaced by a new roof cost-

consisted of four elements (W, X, Y, and Z).ing $50,000, the improvement is the gross addi- Installment Salestion to the account, $50,000, and not the net Step 1. The additional depreciation for eachaddition of $30,000. The $20,000 adjusted basis element is: W-$12,000; X-None; Y-$6,000; and If you report the sale of property under the in-of the old roof is no longer reflected in the basis Z-$6,000. The sum of the additional deprecia- stallment method, any depreciation recaptureof the property. The status of an addition to the tion for all the elements is $24,000. under section 1245 or 1250 is taxable as ordi-capital account is not affected by whether it is Step 2. The depreciation deducted on ele- nary income in the year of sale. This appliestreated as a separate property for determining ment X was $4,000 less than it would have been even if no payments are received in that year. Ifdepreciation deductions. under the straight line method. Additional depre- the gain is more than the depreciation recapture

Whether an expense is treated as an addi- ciation on the property as a whole is $20,000 income, report the rest of the gain using thetion to the capital account may depend on the ($24,000 − $4,000). $20,000 is lower than the rules of the installment method. For this pur-final disposition of the entire property. If the $25,000 gain on the sale, so $20,000 is used in pose, include the recapture income in your in-expense item property and the basic property Step 2. stallment sale basis to determine your grossare sold in two separate transactions, the entire profit on the installment sale.Step 3. The applicable percentages to besection 1250 property is treated as consisting of If you dispose of more than one asset in aused in Step 3 for the elements are: W-68%;two distinct properties. single transaction, you must figure the gain onX-85%; Y-92%; and Z-100%.

each asset separately so that it may be properlyUnadjusted basis. In figuring the unad- From these facts, the sum of the ordinaryreported. To do this, allocate the selling pricejusted basis as of a certain date, include the income for each element is figured as follows.and the payments you receive in the year of saleactual cost of all previous additions to the capitalto each asset. Report any depreciation recap-account plus those that did not qualify as sepa- Ordinaryture income in the year of sale before using therate improvements. However, the cost of com- Step 1 Step 2 Step 3 Incomeinstallment method for any remaining gain.ponents retired before that date is not included

W..... .50 $10,000 68% $ 6,800 For a detailed discussion of installmentin the unadjusted basis.X...... -0- -0- 85% -0- sales, see Publication 537.

Holding period. Use the following guidelines Y...... .25 5,000 92% 4,600for figuring the applicable percentage for prop- Z...... .25 5,000 100% 5,000 Giftserty with two or more elements. Sum of ordinary income

of separate elements . . . . . . . . . $16,400 If you make a gift of depreciable personal prop-• The holding period of a separate elementerty or real property, you do not have to reportplaced in service before the entire sectionincome on the transaction. However, if the per-1250 property is finished starts on the firstson who receives it (donee) sells or otherwiseGain Treated as Ordinary Incomeday of the month that the separate ele-disposes of the property in a disposition subjectment is placed in service.

To find what part of the gain from the disposition to recapture, the donee must take into account• The holding period for each separate im- of section 1250 property is treated as ordinary the depreciation you deducted in figuring the

provement qualifying as a separate ele- income, follow these steps. gain to be reported as ordinary income.ment starts on the day after the For low-income housing, the donee mustimprovement is acquired or, for improve- 1. In a sale, exchange, or involuntary conver- take into account the donor’s holding period toments constructed, reconstructed, or er- sion of the property, figure the amount refigure the applicable percentage. See Applica-ected, the first day of the month that the alized that is more than the adjusted basis ble Percentage and its discussion Holding pe-improvement is placed in service. of the property. In any other disposition of riod under Section 1250 Property, earlier.

the property, figure the fair market value• The holding period for each improvementthat is more than the adjusted basis. Part gift and part sale or exchange. If younot qualifying as a separate element takes

transfer depreciable personal property or realthe holding period of the basic property. 2. Figure the additional depreciation for theproperty for less than its fair market value in aperiods after 1975.transaction considered to be partly a gift andIf an improvement by itself does not meet the

3. Multiply the lesser of (1) or (2) by the appli- partly a sale or exchange and you have a gain1-year test (greater of $2,000 or 1% of the unad-cable percentage, discussed earlier. Stop because the amount realized is more than yourjusted basis), but it does qualify as a separatehere if this is residential rental property or adjusted basis, you must report ordinary incomeimprovement that is a separate element (whenif (2) is equal to or more than (1). This is (up to the amount of gain) to recapture deprecia-grouped with other improvements made duringthe gain treated as ordinary income be- tion. If the depreciation (additional depreciation,the tax year), determine the start of its holdingcause of additional depreciation. if section 1250 property) is more than the gain,period as follows. Use the first day of a calendar

the balance is carried over to the transferee tomonth that is closest to the middle of the tax 4. Subtract (2) from (1).be taken into account on any later disposition ofyear. If there are two first days of a month that

5. Figure the additional depreciation for peri- the property. However, see Bargain sale to char-are equally close to the middle of the year, useods after 1969 but before 1976. ity, later.the earlier date.

6. Add the lesser of (4) or (5) to the result inFiguring ordinary income attributable to Example. You transferred depreciable per-(3). This is the gain treated as ordinaryeach separate element. Figure ordinary in- sonal property to your son for $20,000. Whenincome because of additional depreciation.come attributable to each separate element as transferred, the property had an adjusted basis

A limit on the amount treated as ordinary incomefollows. to you of $10,000 and a fair market value offor gain on like-kind exchanges and involuntaryStep 1. Divide the element’s additional de- $40,000. You took depreciation of $30,000. You

preciation after 1975 by the sum of all the ele- conversions is explained later. are considered to have made a gift of $20,000,




the difference between the $40,000 fair market Ordinary income due to depreciation must be chinery and you received $1,200 from your firereported on a transfer from an executor, admin- insurance, realizing a gain of $480 ($1,200 −value and the $20,000 sale price to your son.istrator, or trustee to an heir, beneficiary, or $720 adjusted basis). You choose to postponeYou have a taxable gain on the transfer ofother individual if the transfer is a sale or ex- reporting gain, but replacement machinery cost$10,000 ($20,000 sale price minus $10,000 ad-change on which gain is realized. you only $1,000. Your taxable gain under thejusted basis) that must be reported as ordinary

rules for involuntary conversions is limited to theincome from depreciation. You report $10,000 ofExample 1. Janet Smith owned depreciable remaining $200 insurance payment. All your re-your $30,000 depreciation as ordinary income

property that, upon her death, was inherited by placement property is depreciable personalon the transfer of the property, so the remainingher son. No ordinary income from depreciation property, so your ordinary income from depreci-$20,000 depreciation is carried over to your sonis reportable on the transfer, even though the ation is limited to $200.for him to take into account on any later disposi-value used for estate tax purposes is more thantion of the property.the adjusted basis of the property to Janet when Example 3. A fire destroyed office machin-she died. However, if she sold the property ery you bought for $116,000. The depreciationGift to charitable organization. If you givebefore her death and realized a gain and if, deductions were $91,640 and the machineryproperty to a charitable organization, you figurebecause of her method of accounting, the pro- had an adjusted basis of $24,360. You receivedyour deduction for your charitable contributionceeds from the sale are income in respect of a a $117,000 insurance payment, realizing a gainby reducing the fair market value of the propertydecedent reportable by her son, he must report of $92,640.by the ordinary income and short-term capitalordinary income from depreciation. You immediately spent $105,000 of the in-gain that would have resulted had you sold the

surance payment for replacement machineryproperty at its fair market value at the time of theExample 2. The trustee of a trust created by and $9,000 for stock that qualifies as replace-contribution. Thus, your deduction for deprecia-

a will transfers depreciable property to a benefi- ment property and you choose to postpone re-ble real or personal property given to a charita-ciary in satisfaction of a specific bequest of porting the gain. $114,000 of the $117,000ble organization does not include the potential$10,000. If the property had a value of $9,000 at insurance payment was used to buy replace-ordinary gain from depreciation.the date used for estate tax valuation purposes, ment property, so the gain that must be includedYou also may have to reduce the fair market the $1,000 increase in value to the date of distri- in income under the rules for involuntary conver-value of the contributed property by the bution is a gain realized by the trust. Ordinary sions is the part not spent, or $3,000. The part oflong-term capital gain (including any section income from depreciation must be reported by the insurance payment ($9,000) used to buy the1231 gain) that would have resulted had the the trust on the transfer. nondepreciable property (the stock) also mustproperty been sold. For more information, see

be included in figuring the gain from deprecia-Giving Property That Has Increased in Value in

tion.Like-Kind ExchangesPublication 526, Charitable Contributions.The amount you must report as ordinary in-and Involuntary

come on the transaction is $12,000, figured asBargain sale to charity. If you transfer sec- Conversions follows.tion 1245 or section 1250 property to a charita-

A like-kind exchange of your depreciable prop-ble organization for less than its fair market 1) Gain realized on the transactionerty or an involuntary conversion of the propertyvalue and a deduction for the contribution part of ($92,640) limited to depreciationinto similar or related property will not result inthe transfer is allowable, your ordinary income ($91,640) . . . . . . . . . . . . . . . . . $91,640your having to report ordinary income from de-from depreciation is figured under differentpreciation unless money or property other thanrules. First, figure the ordinary income as if you 2) Gain includible in incomelike-kind, similar, or related property is also re-had sold the property at its fair market value. (amount not spent) . . . . . . $3,000ceived in the transaction. For information onThen, allocate that amount between the sale Plus: fair market value oflike-kind exchanges and involuntary conver- property other thanand the contribution parts of the transfer in thesions, see chapter 1. depreciable personalsame proportion that you allocated your ad-

property (the stock) . . . . . . 9,000 12,000justed basis in the property to figure your gain.Depreciable personal property. If you haveSee Bargain Sale under Gain or Loss Froma gain from either a like-kind exchange or an Amount reportable as ordinarySales and Exchanges in chapter 1. Report asinvoluntary conversion of your depreciable per- income (lesser of (1) or (2)) . . . . . . $12,000ordinary income the lesser of the ordinary in-sonal property, the amount to be reported ascome allocated to the sale or your gain from the If, instead of buying $9,000 in stock, youordinary income from depreciation is the amountsale. bought $9,000 worth of depreciable personalfigured under the rules explained earlier (see

property similar or related in use to the de-Section 1245 Property), limited to the sum of theExample. You sold section 1245 property in stroyed property, you would only report $3,000following amounts.a bargain sale to a charitable organization and as ordinary income.are allowed a deduction for your contribution. • The gain that must be included in incomeYour gain on the sale was $1,200, figured by Depreciable real property. If you have a gainunder the rules for like-kind exchanges orallocating 20% of your adjusted basis in the from either a like-kind exchange or involuntaryinvoluntary conversions.property to the part sold. If you had sold the conversion of your depreciable real property,• The fair market value of the like-kind, simi-property at its fair market value, your ordinary ordinary income from additional depreciation is

lar, or related property other than depre-income would have been $5,000. Your ordinary figured under the rules explained earlier (seeciable personal property acquired in theincome is $1,000 ($5,000 × 20%) and your sec- Section 1250 Property), limited to the greater oftransaction.tion 1231 gain is $200 ($1,200 - $1,000). the following amounts.

• The gain that must be reported under theTransfers at Death Example 1. You bought a new machine for rules for like-kind exchanges or involun-$4,300 cash plus your old machine for which you tary conversions plus the fair market valueWhen a taxpayer dies, no gain is reported on were allowed a $1,360 trade-in. The old ma- of stock bought as replacement property indepreciable personal property or real property chine cost you $5,000 two years ago. You took acquiring control of a corporation.transferred to his or her estate or beneficiary. depreciation deductions of $3,950. Even though

For information on the tax liability of a decedent, • The gain you would have had to report asyou deducted depreciation of $3,950, the $310see Publication 559, Survivors, Executors, and ordinary income from additional deprecia-gain ($1,360 trade-in allowance minus $1,050Administrators. tion had the transaction been a cash saleadjusted basis) is not reported because it is

However, if the decedent disposed of the minus the cost (or fair market value in anpostponed under the rules for like-kind ex-property while alive and, because of his or her exchange) of the depreciable real propertychanges and you received only depreciable per-method of accounting or for any other reason, acquired.sonal property in the exchange.the gain from the disposition is reportable by theestate or beneficiary, it must be reported in the Example 2. You bought office machinery for The ordinary income not reported for the yearsame way the decedent would have had to re- $1,500 two years ago and deducted $780 de- of the disposition is carried over to the deprecia-port it if he or she were still alive. preciation. This year a fire destroyed the ma- ble real property acquired in the like-kind ex-




change or involuntary conversion as additional item of other property, allocate this basis their respective fair market values to figure thedepreciation from the property disposed of. Fur- amount among the properties in proportion part of your gain to be reported as ordinaryther, to figure the applicable percentage of addi- to their fair market value (or cost). income from depreciation. Different rules maytional depreciation to be treated as ordinary apply to the allocation of the amount realized onincome, the holding period starts over for the the sale of a business that includes a group ofExample 1. In 1986, low-income housingnew property. assets. See chapter 2.property that you acquired and placed in service

In general, if a buyer and seller have adversein 1981 was destroyed by fire and you receivedExample. The state paid you $116,000 interests as to the allocation of the amount real-a $90,000 insurance payment. The property’s

when it condemned your depreciable real prop- ized between the depreciable property and otheradjusted basis was $38,400, with additional de-erty for public use. You bought other real prop- property, any arm’s-length agreement betweenpreciation of $14,932. On December 1, 1986,erty similar in use to the property condemned for them will establish the allocation.you used the insurance payment to acquire and$110,000 ($15,000 for depreciable real property In the absence of an agreement, the alloca-place in service replacement low-income hous-and $95,000 for land). You also bought stock for tion should be made by taking into account theing property.$5,000 to get control of a corporation owning appropriate facts and circumstances. These in-Your realized gain from the involuntary con-property similar in use to the property con- clude, but are not limited to, a comparison be-version was $51,600 ($90,000 − $38,400). Youdemned. You choose to postpone reporting the tween the depreciable property and all the otherchose to postpone reporting the gain under thegain. If the transaction had been a sale for cash property being disposed of in the transaction.involuntary conversion rules. Under the rules foronly, under the rules described earlier, $20,000 The comparison should take into account all thedepreciation recapture on real property, the ordi-would have been reportable as ordinary income following facts and circumstances.nary gain was $14,932, but you did not have tobecause of additional depreciation.

report any of it because of the limit for involun- • The original cost and reproduction cost ofThe ordinary income to be reported istary conversions. construction, erection, or production.$6,000, which is the greater of the following

The basis of the replacement low-incomeamounts. • The remaining economic useful life.housing property was its $90,000 cost minus the$51,600 gain you postponed, or $38,400. The1. The gain that must be reported under the • The state of obsolescence.$14,932 ordinary gain you did not report isrules for involuntary conversions, $1,000

• The anticipated expenditures required totreated as additional depreciation on the re-($116,000 − $115,000) plus the fair marketmaintain, renovate, or modernize theplacement property. When you dispose of thevalue of stock bought as qualified replace-properties.property, your holding period for figuring thement property, $5,000, for a total of

applicable percentage of additional depreciation$6,000.to report as ordinary income will have begun Like-kind exchanges and involuntary con-2. The gain you would have had to report as December 2, 1986, the day after you acquired versions. If you dispose of and acquire bothordinary income from additional deprecia- the property. depreciable personal property and other prop-tion ($20,000) had this transaction been a

erty (other than depreciable real property) in acash sale minus the cost of the deprecia- Example 2. John Adams received a like-kind exchange or involuntary conversion,ble real property bought ($15,000), or $90,000 fire insurance payment for depreciable the amount realized is allocated in the following$5,000. real property (office building) with an adjusted way. The amount allocated to the depreciablebasis of $30,000. He uses the whole payment toThe ordinary income not reported, $14,000 personal property disposed of is treated as con-buy property similar in use, spending $42,000($20,000 − $6,000), is carried over to the depre- sisting of, first, the fair market value of the depre-for depreciable real property and $48,000 forciable real property you bought as additional ciable personal property acquired and, secondland. He chooses to postpone reporting thedepreciation. (to the extent of any remaining balance), the fair$60,000 gain realized on the involuntary conver- market value of the other property acquired. TheBasis of property acquired. If the ordinary sion. Of this gain, $10,000 is ordinary income amount allocated to the other property disposedincome you have to report because of additional from additional depreciation but is not reported of is treated as consisting of the fair marketdepreciation is limited, the total basis of the because of the limit for involuntary conversions value of all property acquired that has not al-property you acquired is its fair market value (its of depreciable real property. The basis of the ready been taken into account.cost, if bought to replace property involuntarily property bought is $30,000 ($90,000 − $60,000), If you dispose of and acquire depreciableconverted into money) minus the gain post- allocated as follows. real property and other property in a like-kindponed.

exchange or involuntary conversion, the amountIf you acquired more than one item of prop- 1. The $42,000 cost of depreciable real prop-realized is allocated in the following way. Theerty, allocate the total basis among the proper- erty minus $10,000 ordinary income notamount allocated to each of the three types ofties in proportion to their fair market value (their reported is $32,000.property (depreciable real property, depreciablecost, in an involuntary conversion into money).

2. The $48,000 cost of other property (land) personal property, or other property) disposed ofHowever, if you acquired both depreciable realplus the $32,000 figured in (1) is $80,000. is treated as consisting of, first, the fair marketproperty and other property, allocate the total

value of that type of property acquired and, sec-basis as follows. 3. The $32,000 figured in (1) divided by theond (to the extent of any remaining balance),$80,000 figured in (2) is 0.4.

1. Subtract the ordinary income because of any excess fair market value of the other types4. The basis of the depreciable real propertyadditional depreciation that you do not of property acquired. If the excess fair market

is $12,000. This is the $30,000 total basishave to report from the fair market value value is more than the remaining balance of themultiplied by the 0.4 figured in (3).(or cost) of the depreciable real property amount realized and is from both of the other

acquired. two types of property, you can apply the unallo-5. The basis of the other property (land) iscated amount in any manner you choose.$18,000. This is the $30,000 total basis2. Add the fair market value (or cost) of the

minus the $12,000 figured in (4).other property acquired to the result in (1). Example. A fire destroyed your propertyThe ordinary income that is not reported with a total fair market value of $50,000. It con-3. Divide the result in (1) by the result in (2).

($10,000) is carried over as additional deprecia- sisted of machinery worth $30,000 and nonde-4. Multiply the total basis by the result in (3). tion to the depreciable real property that was preciable property worth $20,000. You received

This is the basis of the depreciable real bought and may be taxed as ordinary income on an insurance payment of $40,000 and immedi-property acquired. If you acquired more a later disposition. ately used it with $10,000 of your own funds (forthan one item of depreciable real property, a total of $50,000) to buy machinery with a fairallocate this basis amount among the market value of $15,000 and nondepreciableMultiple Propertiesproperties in proportion to their fair market property with a fair market value of $35,000. Thevalue (or cost). If you dispose of both depreciable property and adjusted basis of the destroyed machinery was

5. Subtract the result in (4) from the total ba- other property in one transaction and realize a $5,000 and your depreciation on it was $35,000.sis. This is the basis of the other property gain, you must allocate the amount realized be- You choose to postpone reporting your gainacquired. If you acquired more than one tween the two types of property in proportion to from the involuntary conversion. You must re-




port $9,000 as ordinary income from deprecia- gain or loss according to the sales price, which isUseful Itemsthe total amount you realized on the transaction.tion arising from this transaction, figured as You may want to see:

follows. Publication

1. The $40,000 insurance payment must be❏ 550 Investment Income and Expenses Schedule Dallocated between the machinery and the❏ 537 Installment Salesother property destroyed in proportion to (Form 1040)the fair market value of each. The amount ❏ 954 Tax Incentives for Distressed

allocated to the machinery is 30,000/ Communities Use Schedule D (Form 1040) to report sales,50,000 x $40,000, or $24,000. The amount

exchanges, and other dispositions of capital as-allocated to the other property is 20,000/ Form (and Instructions) sets. Before completing Schedule D, you may50,000 x $40,000, or $16,000. Your gain have to complete other forms as shown below.❏ Schedule D (Form 1040) Capital Gainson the involuntary conversion of the ma-

and Losses • For a sale, exchange, or involuntary con-chinery is $24,000 minus $5,000 adjustedversion of business property, complete❏ 1099-B Proceeds From Broker andbasis, or $19,000.Form 4797.Barter Exchange Transactions

2. The $24,000 allocated to the machinery• For a like-kind exchange, complete Form❏ 1099-S Proceeds From Real Estatedisposed of is treated as consisting of the

Transactions 8824. See Reporting the exchange under$15,000 fair market value of the replace-Like-Kind Exchanges in chapter 1.ment machinery bought and $9,000 of the ❏ 4684 Casualties and Thefts

fair market value of other property bought • For an installment sale, complete Form❏ 4797 Sales of Business Propertyin the transaction. All $16,000 allocated to 6252. See Publication 537.

❏ 6252 Installment Sale Incomethe other property disposed of is treated as • For an involuntary conversion due to casu-consisting of the fair market value of the ❏ 8824 Like-Kind Exchanges alty or theft, complete Form 4684. Seeother property that was bought.

Publication 547, Casualties, Disasters,See chapter 5 for information about getting3. Your potential ordinary income from depre- and Thefts.

publications and forms.ciation is $19,000, the gain on the machin- • For a disposition of an interest in, or prop-ery, because it is less than the $35,000 erty used in, an activity to which the at-riskdepreciation. However, the amount you rules apply, complete Form 6198, At-Riskmust report as ordinary income is limited to Limitations. See Publication 925, PassiveInformation Returnsthe $9,000 included in the amount realized Activity and At-Risk Rules.for the machinery that represents the fair

If you sell or exchange certain assets, you • For a disposition of an interest in, or prop-market value of property other than the should receive an information return showing erty used in, a passive activity, completedepreciable property you bought. the proceeds of the sale. This information is also Form 8582, Passive Activity Loss Limita-provided to the Internal Revenue Service. tions. See Publication 925.

Form 1099-B. If you sold stocks, bonds, com-Personal-use property. Report gain on themodities, etc., you should receive Form 1099-Bsale or exchange of property held for personalor an equivalent statement. Whether or not youuse (such as your home) on Schedule D. Lossreceive Form 1099-B, you must report all tax-

able sales of stocks, bonds, commodities, etc., from the sale or exchange of property held for4. on Schedule D. For more information on figuring personal use is not deductible. But if you had agains and losses from these transactions, see loss from the sale or exchange of real estatechapter 4 in Publication 550. held for personal use for which you received a

Form 1099-S, report the transaction on Sched-Form 1099-S. An information return must beReporting Gains ule D, even though the loss is not deductible.provided on certain real estate transactions. Complete columns (a) through (e) and enter -0-Generally, the person responsible for closing the in column (f).and Losses transaction must report on Form 1099-S sales orexchanges of the following types of property. Long and Short Term

• Land (improved or unimproved), includingWhere you report a capital gain or loss dependsair space.Introductionon how long you own the asset before you sell or

• An inherently permanent structure, includ-This chapter explains how to report capital gains exchange it. The time you own an asset beforeing any residential, commercial, or indus-and losses and ordinary gains and losses from disposing of it is the holding period.trial building.sales, exchanges, and other dispositions of If you hold a capital asset 1 year or less, the

• A condominium unit and its related fixturesproperty. gain or loss from its disposition is short term.and common elements (including land). Report it in Part I of Schedule D. If you hold aAlthough this discussion refers to Schedule

capital asset longer than 1 year, the gain or loss• Stock in a cooperative housing corpora-D (Form 1040), the rules discussed here alsofrom its disposition is long term. Report it in Parttion.apply to taxpayers other than individuals. How-II of Schedule D (Form 1040).ever, the rules for property held for personal use If you sold or exchanged any of the above types

usually will not apply to taxpayers other than of property, the reporting person must give you a Table 4-1. Do I Have a Short-Termindividuals. copy of Form 1099-S or a statement containing or Long-Term Gain or Loss?

the same information as the Form 1099-S.Topics IF you hold theIf you receive or will receive property or serv-

property... THEN you have a...ices in addition to gross proceeds (cash orThis chapter discusses:notes) in this transaction, the person reporting it 1 year or less, Short-term capital gain or

loss.does not have to value that property or those• Information returnsservices. In that case, the gross proceeds re- More than 1 year, Long-term capital gain or• Schedule D (Form 1040)ported on Form 1099-S will be less than the loss.• Form 4797 sales price of the property you sold. Figure any

Page 32 Chapter 4 Reporting Gains and Losses



These distinctions are essential to correctly the machinery you got in the exchange. Your Net short-term capital gain or loss. Com-arrive at your net capital gain or loss. Capital bine your short-term capital gains and losses,holding period for this machinery began on De-losses are allowed in full against capital gains including your share of short-term capital gainscember 5, 2003. Therefore, you held it longerplus up to $3,000 of ordinary income. See Capi- or losses from partnerships, S corporations, andthan 1 year.tal Gains Tax Rates, later. fiduciaries and any short-term capital loss carry-

Corporate liquidation. The holding period over. Do this by adding all your short-term capi-for property you receive in a liquidation generallyHolding period. To figure if you held property tal gains. Then add all your short-term capitalstarts on the day after you receive it if gain orlonger than 1 year, start counting on the day losses. Subtract the lesser total from the other.loss is recognized.following the day you acquired the property. The The result is your net short-term capital gain or

day you disposed of the property is part of your loss.Profit-sharing plan. The holding period ofholding period. common stock withdrawn from a qualified con- Net long-term capital gain or loss. Follow

tributory profit-sharing plan begins on the day the same steps to combine your long-term capi-Example. If you bought an asset on June following the day the plan trustee delivered the tal gains and losses. Include the following items.19, 2003, you should start counting on June 20, stock to the transfer agent with instructions to2003. If you sold the asset on June 19, 2004, • Net section 1231 gain from Part I, Formreissue the stock in your name.your holding period is not longer than 1 year, but 4797, after any adjustment for nonrecap-if you sold it on June 20, 2004, your holding Gift. If you receive a gift of property and your tured section 1231 losses from prior taxperiod is longer than 1 year. basis in it is figured using the donor’s basis, your years.

holding period includes the donor’s holding pe-Patent property. If you dispose of patent • Capital gain distributions from regulatedriod. For more information on basis, see Publi-property, you generally are considered to have investment companies (mutual funds) andcation 551, Basis of Assets.held the property longer than 1 year, no matter real estate investment trusts.how long you actually held it. For more informa- Real property. To figure how long you held • Your share of long-term capital gains ortion, see Patents in chapter 2. real property, start counting on the day after you losses from partnerships, S corporations,

received title to it or, if earlier, the day after youInherited property. If you inherit property, and fiduciaries.took possession of it and assumed the burdensyou are considered to have held the property

• Any long-term capital loss carryover.and privileges of ownership.longer than 1 year, regardless of how long youactually held it. However, taking possession of real property The result from combining these items with

under an option agreement is not enough to start other long-term capital gains and losses is yourInstallment sale. The gain from an install-the holding period. The holding period cannot net long-term capital gain or loss.ment sale of an asset qualifying for long-termstart until there is an actual contract of sale. Thecapital gain treatment in the year of sale contin-holding period of the seller cannot end before Net gain. If the total of your capital gains isues to be long term in later tax years. If it is short

more than the total of your capital losses, thethat time.term in the year of sale, it continues to be shortdifference is taxable. However, the part that isterm when payments are received in later tax Repossession. If you sell real property but not more than your net capital gain may be taxedyears. keep a security interest in it and then later repos- at a rate that is lower than the rate of tax on your

sess it, your holding period for a later sale in-The date the installment payment is ordinary income. See Capital Gains Tax Rates,cludes the period you held the property beforereceived determines the capital gains later.the original sale, as well as the period after therate that should be applied not the date

TIP

Net loss. If the total of your capital losses isrepossession. Your holding period does not in-the asset was sold under an installment con-more than the total of your capital gains, theclude the time between the original sale and thetract.difference is deductible. But there are limits onrepossession. That is, it does not include the

Nontaxable exchange. If you acquire an how much loss you can deduct and when youperiod during which the first buyer held the prop-asset in exchange for another asset and your can deduct it. See Treatment of Capital Losses,erty.basis for the new asset is figured, in whole or in next.

Nonbusiness bad debts. Nonbusinesspart, by using your basis in the old property, thebad debts are short-term capital losses. For in-holding period of the new property includes the Treatment of Capital Lossesformation on nonbusiness bad debts, see chap-holding period of the old property. That is, itter 4 of Publication 550.begins on the same day as your holding period If your capital losses are more than your capital

for the old property. gains, you must deduct the difference even ifNet Gain or Loss you do not have ordinary income to offset it. The

Example. You bought machinery on De- yearly limit on the amount of the capital loss youThe totals for short-term capital gains andcember 4, 2003. On June 4, 2004, you traded can deduct is $3,000 ($1,500 if you are marriedlosses and the totals for long-term capital gainsthis machinery for other machinery in a nontax- and file a separate return).

able exchange. On December 5, 2004, you sold and losses must be figured separately.Capital loss carryover. Generally, you havea capital loss carryover if either of the followingTable 4-2. Holding Period for Different Types of Acquisitionssituations applies to you.

Type of acquisition: When your holding period starts: • Your net loss on Schedule D, line 16, ismore than the yearly limit.Stocks and bonds bought on a Day after trading date you bought security. Ends on trading

securities market date you sold security. • The amount shown on Form 1040, line 40(your taxable income without your deduc-U.S. Treasury notes and bonds If bought at auction, day after notification of bid acceptance.tion for exemptions), is less than zero.If bought through subscription, day after subscription was

submitted. If either of these situations applies to you for2004, see Capital Losses under Reporting Capi-Nontaxable exchanges Day after date you acquired old property.tal Gains and Losses in chapter 4 of Publication

Gift If your basis is giver’s adjusted basis, same day as giver’s 550 to figure the amount you can carry over toholding period began. If your basis is FMV, day after date of 2005.gift.

Example. Bob and Gloria Sampson soldReal property bought Generally, day after date you received title to the property.property in 2004. The sale resulted in a capital

Real property repossessed Day after date you originally received title to the property, but loss of $7,000. The Sampsons had no otherdoes not include time between the original sale and date of capital transactions. On their joint 2004 return,repossession. the Sampsons deduct $3,000, the yearly limit.

They had taxable income of $2,000. The unused

Chapter 4 Reporting Gains and Losses Page 33



part of the loss, $4,000 ($7,000 − $3,000), is Unrecaptured section 1250 gain. This is the it. She realized a gain of $3,000. The gain wascarried over to 2005. part of any long-term capital gain on section less than the $6,000 depreciation taken, so all

If the Sampsons’ capital loss had been 1250 property (real property) that is due to de- her gain is ordinary income from depreciation.$2,000, it would not have been more than the preciation. Unrecaptured section 1250 gain can- This amount is reported in Part III of Form 4797yearly limit. Their capital loss deduction would not be more than the net section 1231 gain or and entered in Part II on line 13.have been $2,000. They would have no carry- include any gain otherwise treated as ordinary The adjusted basis of the customer parkingover to 2005. income. Use the worksheet in the Schedule D lot (acquired in 1980) was $6,000 and its sales

instructions to figure your unrecaptured section price was $8,000. Jane reports her $2,000 gainShort-term and long-term losses. When you 1250 gain. For more information about section from the sale in Part I of Form 4797.carry over a loss, it retains its original character 1250 property and net section 1231 gain, seeJane had a nonrecaptured net section 1231as either long term or short term. A short-term chapter 3.

loss of $1,200. She shows this loss in Part I onloss you carry over to the next tax year is addedline 8. The net section 1231 gain of $2,000 isto short-term losses occurring in that year. Amore than the nonrecaptured loss, so that gainlong-term loss you carry over to the next tax year

is added to long-term losses occurring in that is treated as ordinary gain only up to the loss.Form 4797year. A long-term capital loss you carry over to Therefore, the loss of $1,200 on line 8 is enteredthe next year reduces that year’s long-term as an ordinary gain in Part II on line 12. The lossUse Form 4797 to report gain or loss from agains before its short-term gains. is also subtracted from the $2,000 gain on line 7.sale, exchange, or involuntary conversion of

If you have both short-term and long-term The $800 balance is entered on line 9.property used in your trade or business or that islosses, your short-term losses are used first

depreciable or amortizable. You can use Formagainst your allowable capital loss deduction. If, Form 88244797 with Forms 1040, 1065, 1120, or 1120S.after using your short-term losses, you have notreached the limit on the capital loss deduction, Jane entered into a like-kind exchange by trad-Section 1231 gains and losses. Show anyuse your long-term losses until you reach the ing her business real property for other businesssection 1231 gains and losses in Part I. Carry alimit. real property, so she must report the transactionnet gain to Schedule D (Form 1040) as a

on Form 8824 and attach the form to her taxTo figure your capital loss carryover long-term capital gain. Carry a net loss to Part IIreturn.from 2003 to 2004, use the Capital of Form 4797 as an ordinary loss.

Loss Carryover Worksheet in the 2004 On lines 16 and 17 of Form 8824, JaneTIP

If you had any nonrecaptured net sectionInstructions for Schedule D (Form 1040). enters the fair market value of her new property,1231 losses from the preceding 5 tax years,

$120,000, consisting of $95,000 for the buildingreduce your net gain by those losses and reportJoint and separate returns. On a joint return, and $25,000 for the land. On line 18, she entersthe amount of the reduction as an ordinary gainthe capital gains and losses of a husband and the adjusted basis of the old property, $100,000,in Part II. Report any remaining gain on Sched-wife are figured as the gains and losses of an consisting of $17,687 for the building andule D (Form 1040). See Section 1231 Gains andindividual. If you are married and filing a sepa- $82,313 for the land. Her realized gain on line 19Losses in chapter 3.rate return, your yearly capital loss deduction is is $20,000. Under the like-kind exchange rules,limited to $1,500. Neither you nor your spouse this gain is not recognized. Jane enters “-0-” onOrdinary gains and losses. Show any ordi-can deduct any part of the other’s loss. line 20.nary gains and losses in Part II. This includes a

If you and your spouse once filed separate net loss or a recapture of losses from prior years However, because there is additional depre-returns and are now filing a joint return, combine figured in Part I of Form 4797. It also includes ciation of $4,405 on the old building, Jane mustyour separate capital loss carryovers. However, ordinary gain figured in Part III. determine whether any of her gain has to beif you and your spouse once filed jointly and arerecognized as ordinary income under the recap-now filing separately, any capital loss carryover Ordinary income from depreciation. Figure ture rules. The old building has an FMV offrom the joint return can be deducted only on the the ordinary income from depreciation on per- $90,000. Had the transaction been a cash sale,return of the spouse who actually had the loss. sonal property and additional depreciation on Jane’s realized gain on the building would have

real property (as discussed in chapter 3) in Part been $72,313 ($90,000 - $17,687). The addi-Death of taxpayer. Capital losses cannot beIII. Carry the ordinary income to Part II of Form tional depreciation is less than that amount, socarried over after a taxpayer’s death. They are4797 as an ordinary gain. Carry any remaining her ordinary income due to the additional depre-deductible only on the final income tax returngain to Part I as section 1231 gain, unless it is ciation would have been $4,405. That amount isfiled on the decedent’s behalf. The yearly limitfrom a casualty or theft. Carry any remaining less than the $95,000 fair market value of thediscussed earlier still applies in this situation.gain from a casualty or theft to Form 4684. new building, so there is no ordinary incomeEven if the loss is greater than the limit, the

recognized on the exchange. The $4,405 ordi-decedent’s estate cannot deduct the differencenary income that does not have to be reported isor carry it over to following years.carried over to the new building as additionalExampleCorporations. A corporation can deduct capi- depreciation. Jane enters “-0-” on Form 8824,

tal losses only up to the amount of its capital line 21 and Form 4797, line 16.Jane Smith is single. At the beginning of 2004,gains. In other words, if a corporation has a net All of Jane’s $20,000 gain is deferred (lineshe owned and operated Jane’s Dress Shop atcapital loss, it cannot be deducted in the current 24). The basis of her new property (line 25) is25 Main Street, Smalltown, Virginia. On Marchtax year. It must be carried to other tax years $100,000, the same as the adjusted basis of her16, she traded the land and building where sheand deducted from capital gains occurring in old property. Of that amount, $79,167 [($95,000operated her dress shop for other land and athose years. For more information, see Publica- ÷ $120,000) × $100,000] is allocated to thebuilding around the corner at 97 Oak Street. Shetion 542.

building and $20,833 [($25,000 ÷ $120,000) ×then opened the J. Smith Hardware Store. Jane$100,000] is allocated to the land.also sold all the equipment she had used in herCapital Gains Tax Rates

dress shop, as well as a vacant lot across theSummarystreet from the shop used for customer parking.The tax rates that apply to a net capital gain are

She reports these transactions as shown in thegenerally lower than the tax rates that apply toThe entries in Part II, Form 4797, show an ordi-filled-in Form 4797 and Form 8824 at the end ofother income. These lower rates are called thenary gain of $4,200 that is carried to Form 1040,this chapter.maximum capital gains rates.line 14.The term “net capital gain” means the

The entries in Part I, Form 4797, result in aamount by which your net long-term capital gain Form 4797long-term capital gain of $800 from section 1231for the year is more than your net short-term

Jane sold the equipment she used in her dresscapital loss. transactions. This is carried to Schedule Dshop for $3,000. She originally paid $6,000 for itSee the Schedule D (Form 1040) Instruc- (Form 1040), line 11, column (f).on January 20, 1986, and had fully depreciatedtions.




Sales of Business Property(Also Involuntary Conversions and Recapture Amounts

Under Sections 179 and 280F(b)(2))Department of the Treasury Internal Revenue Service

AttachmentSequence No. 27�Attach to your tax return.

Identifying numberName(s) shown on return

Sales or Exchanges of Property Used in a Trade or Business and Involuntary Conversions From OtherThan Casualty or Theft—Most Property Held More Than 1 Year (see instructions)

Enter the gross proceeds from sales or exchanges reported to you for 2004 on Form(s) 1099-B or 1099-S (or substitutestatement) that you are including on line 2, 10, or 20 (see instructions)

11

(f) Cost or otherbasis, plus

improvements andexpense of sale

(e) Depreciationallowed or

allowable sinceacquisition

(g) Gain or (loss)Subtract (f) from the

sum of (d) and (e)

(c) Date sold(mo., day, yr.)

(b) Date acquired(mo., day, yr.)

(a) Descriptionof property

(d) Grosssales price

2

Gain, if any, from Form 4684, line 393

Section 1231 gain from installment sales from Form 6252, line 26 or 374

Gain, if any, from line 32, from other than casualty or theft

5

Combine lines 2 through 6. Enter the gain or (loss) here and on the appropriate line as follows:

6

7

Partnerships (except electing large partnerships) and S corporations. Report the gain or (loss) following the instructionsfor Form 1065, Schedule K, line 10, or Form 1120S, Schedule K, line 9. Skip lines 8, 9, 11, and 12 below.

All others. If line 7 is zero or a loss, enter the amount from line 7 on line 11 below and skip lines 8 and 9. If line7 is a gain and you did not have any prior year section 1231 losses, or they were recaptured in an earlier year,enter the gain from line 7 as a long-term capital gain on Schedule D and skip lines 8, 9, 11, and 12 below.

Nonrecaptured net section 1231 losses from prior years (see instructions)89 Subtract line 8 from line 7. If zero or less, enter -0-. If line 9 is zero, enter the gain from line 7 on line 12 below. If

line 9 is more than zero, enter the amount from line 8 on line 12 below and enter the gain from line 9 as a long-termcapital gain on Schedule D (see instructions)

Ordinary Gains and Losses

Ordinary gains and losses not included on lines 11 through 16 (include property held 1 year or less):

Loss, if any, from line 7

10

Gain, if any, from line 7 or amount from line 8, if applicable

11

Gain, if any, from line 31

12

Net gain or (loss) from Form 4684, lines 31 and 38a

13

Ordinary gain from installment sales from Form 6252, line 25 or 36

14

15

Combine lines 10 through 16

16

b

If the loss on line 11 includes a loss from Form 4684, line 35, column (b)(ii), enter that part of the loss here. Enterthe part of the loss from income-producing property on Schedule A (Form 1040), line 27, and the part of the lossfrom property used as an employee on Schedule A (Form 1040), line 22. Identify as from “Form 4797, line 18a.”See instructions

Redetermine the gain or (loss) on line 17 excluding the loss, if any, on line 18a. Enter here and on Form 1040,line 14

Form 4797 (2004)For Paperwork Reduction Act Notice, see page 8 of the instructions. Cat. No. 13086I

Part I

Part II

OMB No. 1545-0184

Section 1231 gain or (loss) from like-kind exchanges from Form 8824

Ordinary gain or (loss) from like-kind exchanges from Form 8824

17

3

4

5

6

7

8

11

12

13

14

15

16

17

18a

18b

(99)

9

( )

4797Form 2004

a

For all except individual returns, enter the amount from line 17 on the appropriate line of your return and skip linesa and b below. For individual returns, complete lines a and b below:

18

�See separate instructions.

Jane Smith 458-00-0327

Customer parking lot 10-1-80 3-16-04 8,000 -0- 6,000 2,000

2,000

1,200

800

1,2003,000

4,200

4,200

-0-




Page 2Form 4797 (2004)

Gain From Disposition of Property Under Sections 1245, 1250, 1252, 1254, and 1255

(c) Date sold(mo., day, yr.)

(b) Date acquired(mo., day, yr.)(a) Description of section 1245, 1250, 1252, 1254, or 1255 property:

A

BC

D

Property DProperty CProperty BProperty AThese columns relate to the properties on lines 19A through 19D. �

Gross sales price (Note: See line 1 before completing.)

Cost or other basis plus expense of sale

19

Depreciation (or depletion) allowed or allowable

20

Adjusted basis. Subtract line 22 from line 21

21

Total gain. Subtract line 23 from line 20

22

If section 1245 property:

23

a Depreciation allowed or allowable from line 22b Enter the smaller of line 24 or 25a

If section 1250 property: If straight line depreciation was used, enter-0- on line 26g, except for a corporation subject to section 291.

24

Additional depreciation after 1975 (see instructions)a

Applicable percentage multiplied by the smaller of line 24or line 26a (see instructions)

b

Subtract line 26a from line 24. If residential rental propertyor line 24 is not more than line 26a, skip lines 26d and 26e

c

Additional depreciation after 1969 and before 1976d

Enter the smaller of line 26c or 26def Section 291 amount (corporations only)g Add lines 26b, 26e, and 26f

25

If section 1252 property: Skip this section if you did notdispose of farmland or if this form is being completed for apartnership (other than an electing large partnership).

Soil, water, and land clearing expensesaLine 27a multiplied by applicable percentage (see instructions)bEnter the smaller of line 24 or 27bc


26

Intangible drilling and development costs, expenditures fordevelopment of mines and other natural deposits, andmining exploration costs (see instructions)

a

Enter the smaller of line 24 or 28ab


27

Applicable percentage of payments excluded from incomeunder section 126 (see instructions)

a

Enter the smaller of line 24 or 29a (see instructions)b

Summary of Part III Gains. Complete property columns A through D through line 29b before going to line 30.

Total gains for all properties. Add property columns A through D, line 24

28

Add property columns A through D, lines 25b, 26g, 27c, 28b, and 29b. Enter here and on line 13

29

Subtract line 31 from line 30. Enter the portion from casualty or theft on Form 4684, line 33. Enter the portionfrom other than casualty or theft on Form 4797, line 6

30

3132

33

Recapture Amounts Under Sections 179 and 280F(b)(2) When Business Use Drops to 50% or Less(see instructions)

(b) Section 280F(b)(2)

(a) Section179

Section 179 expense deduction or depreciation allowable in prior years34 Recomputed depreciation. See instructions35 Recapture amount. Subtract line 34 from line 33. See the instructions for where to report

Part IV

Part III

20

21

22

23

24

25a

26a

27a

28a

29a

26b

26c

26d

26e

26f

26g

27b

27c

28b

29b

25b

30

31

32

33

34

35

Form 4797 (2004)

Store Equipment 1-20-86 3-16-04

3,0006,0006,000

-0-

3,000

6,0003,000

3,000

3,000

-0-




OMB No. 1545-1190Like-Kind Exchanges8824Form(and section 1043 conflict-of-interest sales)

Department of the TreasuryInternal Revenue Service

� Attach to your tax return.AttachmentSequence No. 109

Identifying numberName(s) shown on tax return

Information on the Like-Kind Exchange

Description of like-kind property given up �1

Description of like-kind property received �2

/ /3Date like-kind property given up was originally acquired (month, day, year)3/ /4Date you actually transferred your property to other party (month, day, year)4

/ /5Date like-kind property you received was identified by written notice to another party (seeinstructions for 45-day written notice requirement) (month, day, year)

5

/ /6Date you actually received the like-kind property from other party (month, day, year) (see instructions)67 Was the exchange of the property given up or received made with a related party, either directly or indirectly

(such as through an intermediary) (see instructions)? If “Yes,” complete Part II. If “No,” go to Part III

8 Name of related party Related party’s identifying number

Address (no., street, and apt., room, or suite no., city or town, state, and ZIP code)

Relationship to you

During this tax year (and before the date that is 2 years after the last transfer of property that was part of theexchange), did the related party directly or indirectly (such as through an intermediary) sell or dispose of anypart of the like-kind property received from you in the exchange?

9

During this tax year (and before the date that is 2 years after the last transfer of property that was part of theexchange), did you sell or dispose of any part of the like-kind property you received?

10

If both lines 9 and 10 are “No” and this is the year of the exchange, go to Part III. If both lines 9 and 10 are “No” and this is not theyear of the exchange, stop here. If either line 9 or line 10 is “Yes,” complete Part III and report on this year’s tax return the deferredgain or (loss) from line 24 unless one of the exceptions on line 11 applies.

11 If one of the exceptions below applies to the disposition, check the applicable box:The disposition was after the death of either of the related parties.The disposition was an involuntary conversion, and the threat of conversion occurred after the exchange.You can establish to the satisfaction of the IRS that neither the exchange nor the disposition had tax avoidance as itsprincipal purpose. If this box is checked, attach an explanation (see instructions).

Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property,see Reporting of multi-asset exchanges in the instructions.

Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line 15.12Fair market value (FMV) of other property given up121313 Adjusted basis of other property given up

Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report thegain or (loss) in the same manner as if the exchange had been a sale

1414

15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced(but not below zero) by any exchange expenses you incurred (see instructions) 15

16FMV of like-kind property you received1617Add lines 15 and 1617

Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus anyexchange expenses not used on line 15 (see instructions)

181819Realized gain or (loss). Subtract line 18 from line 1719

Enter the smaller of line 15 or line 19, but not less than zero20 202121 Ordinary income under recapture rules. Enter here and on Form 4797, line 16 (see instructions)

Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and 23

2222

Form 8824 (2004)For Paperwork Reduction Act Notice, see page 4. Cat. No. 12311A

Part I

NoYes

NoYes

Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received

Note: If the property described on line 1 or line 2 is real or personal property located outside the United States, indicate the country.

2324 Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions

Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on ScheduleD or Form 4797, unless the installment method applies (see instructions)Recognized gain. Add lines 21 and 22

25

232425

abc

Part III

Part II Related Party Exchange InformationNoYes

2004

Commercial building and land 25 Main Street, Smalltown, VA 20000

Commercial building and land 97 Oak Street, Smalltown, VA 20000

1 20 863 16 04

3 16 043 16 04

-0-120,000 00120,000 00

100,000 0020,000 00

20,000 00100,000 00

-0--0-

-0--0-

Jane Smith 458-00-0327




• Search publications online by topic or of our telephone services. One method is for akeyword. second IRS representative to sometimes listen

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Page 38 Chapter 5 How To Get Tax Help



• Internal Revenue Bulletins. taxpayer about to start a business. This handy, and quick and incorporates file formats andinteractive CD contains all the business tax browsers that can be run on virtually any

Buy the CD-ROM from National Technical In- forms, instructions, and publications needed to desktop or laptop computer.formation Service (NTIS) at www.irs.gov/ successfully manage a business. In addition, the It is available in early April. You can get acdorders for $22 (no handling fee) or call CD provides other helpful information, such as free copy by calling 1-800-829-3676 or by visit-1-877-233-6767 toll free to buy the CD-ROM for how to prepare a business plan, finding financ- ing www.irs.gov/smallbiz.$22 (plus a $5 handling fee). The first release is ing for your business, and much more. The de-available in early January and the final release is sign of the CD makes finding information easyavailable in late February.

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Chapter 5 How To Get Tax Help Page 39



To help us develop a more useful index, please let us know if you have ideas for index entries.Index See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

Related persons . . . . . . . . . . . . 23 Like-kind property . . . . . . . . . . 11 Replacement property . . . . . 8, 12AU.S. Treasury notes or Multiple parties . . . . . . . . . . . . . 10 Repossession . . . . . . . . . . . . . 4, 33Abandonments . . . . . . . . . . . . . . . 4

bonds . . . . . . . . . . . . . . . . . . . 16 Multiple property . . . . . . . . . . . 14 Residual method, sale ofAnnuities . . . . . . . . . . . . . . . . . . . . 16Partnership interests . . . . . . . . 16 business . . . . . . . . . . . . . . . . . . 21Asset classification:Qualifying property . . . . . . . . . 10 Rollover of gain . . . . . . . . . . . . . 18Capital . . . . . . . . . . . . . . . . . . . . . 19 FRelated persons . . . . . . . . . . . . 15Noncapital . . . . . . . . . . . . . . . . . 19 Fair market value . . . . . . . . . . . . . 3

Like-Kind Exchanges usingAssistance (See Tax help) Foreclosure . . . . . . . . . . . . . . . . . . 4 SQualifiedAssumption of liabilities . . . . 13, Form: Sale of a business . . . . . . . . . . . 21Intermediaries . . . . . . . . . . . . . 1217 1040 (Sch. D) . . . . . . . . . . . . . . 32 Sales:Low-income housing . . . . . . . . 281099-A . . . . . . . . . . . . . . . . . . . 4, 5 Bargain, charitable1099-B . . . . . . . . . . . . . . . . . . . . 32 organization . . . . . . . . . . . 3, 30B

M1099-C . . . . . . . . . . . . . . . . . . . 4, 5 Installment . . . . . . . . . . . . . 29, 33Basis:1099-S . . . . . . . . . . . . . . . . . . . . 32 More information (See Tax help) Property changed to businessAdjusted . . . . . . . . . . . . . . . . . . . . 34797 . . . . . . . . . . . . . . . . . . 10, 34 Multiple property or rental use . . . . . . . . . . . . . . 4Original . . . . . . . . . . . . . . . . . . . . . 38594 . . . . . . . . . . . . . . . . . . . . . . 22 exchanges . . . . . . . . . . . . . . . . 14 Related persons . . . . . . . . 20, 23Bonds, U.S. Treasury . . . . . . . . 168824 . . . . . . . . . . . . . . . . . . . . . . 10 Section 1231 gains andBusiness, sold . . . . . . . . . . . . . . 21

Franchise . . . . . . . . . . . . . . . . . . . 23 losses . . . . . . . . . . . . . . . . . . . . . 25NFree tax services . . . . . . . . . . . . 38 Section 1245 property:Noncapital assetsC Defined . . . . . . . . . . . . . . . . . . . . 25defined . . . . . . . . . . . . . . . . . . . . 19Canceled: Gain, ordinary income . . . . . . 26G Nontaxable exchanges:Debt . . . . . . . . . . . . . . . . . . . . . . . . 4 Multiple asset accounts . . . . . 27Gains and losses: Like-kind . . . . . . . . . . . . . . . . . . . 10Lease . . . . . . . . . . . . . . . . . . . . . . 2 Section 1250 property:Bargain sale . . . . . . . . . . . . . . . . 3 Other nontaxableReal property sale . . . . . . . . . . . 3 Additional depreciation . . . . . 27Business property . . . . . . . . . . 24 exchanges . . . . . . . . . . . . . . . 16Capital assets defined . . . . . . . 19 Defined . . . . . . . . . . . . . . . . . . . . 27Comprehensive Partially . . . . . . . . . . . . . . . . . . . . 13

Capital gains and losses: Foreclosure . . . . . . . . . . . . . . . . 28example . . . . . . . . . . . . . . . . . 34 Property exchanged forFiguring . . . . . . . . . . . . . . . . . . . 32 Gain, ordinary income . . . . . . 29Defined . . . . . . . . . . . . . . . . . . . . . 3 stock . . . . . . . . . . . . . . . . . . . . 17Holding period . . . . . . . . . . . . . 33 Nonresidential . . . . . . . . . . . . . 28Form 4797 . . . . . . . . . . . . . . . . . 34 Notes, U.S. Treasury . . . . . . . . 16Long term . . . . . . . . . . . . . . . . . . 32 Residential . . . . . . . . . . . . . . . . . 28Ordinary or capital . . . . . . . . . . 19Short term . . . . . . . . . . . . . . . . . 32 Section 197 intangibles . . . . . 22Property changed to business OTreatment of capital Severance damages . . . . . . . . . . 7or rental use . . . . . . . . . . . . . . 4

losses . . . . . . . . . . . . . . . . . . . 33 Ordinary or capital gain . . . . . 19Property used partly for Silver . . . . . . . . . . . . . . . . . . . . . . . . 24Casualties . . . . . . . . . . . . . . . . . . . 25 rental . . . . . . . . . . . . . . . . . . . . . 4 Small business stock . . . . . . . . 18Charitable organization: Reporting . . . . . . . . . . . . . . . . . . 32 P Specialized small business

Bargain sale to . . . . . . . . . . . 3, 30 Gifts of property . . . . . . . . . 29, 33 Partially nontaxable investment company (SSBIC),Gift to . . . . . . . . . . . . . . . . . . . . . 30 exchanges . . . . . . . . . . . . . . . . 13Gold . . . . . . . . . . . . . . . . . . . . . . . . 24 rollover of gain into . . . . . . . 18

Coal . . . . . . . . . . . . . . . . . . . . . . . . . 24 Partnership: Stamps . . . . . . . . . . . . . . . . . . . . . . 24Coins . . . . . . . . . . . . . . . . . . . . . . . 24 Controlled . . . . . . . . . . . . . . . . . 20 Stock:HComments . . . . . . . . . . . . . . . . . . . 2 Related persons . . . . . . . . 16, 20 Capital asset . . . . . . . . . . . . . . . 19Hedging transactions . . . . . . . 20Commodities derivative Sale or exchange of Controlling interest,Help (See Tax help)financial instruments . . . . . . 20 interest . . . . . . . . . . . . . . 16, 21 corporation . . . . . . . . . . . . . . . 9Holding period . . . . . . . . . . . . . . 33Condemnations . . . . . . . . . . . 6, 25 Patents . . . . . . . . . . . . . . . . . . . . . . 22 Indirect ownership . . . . . . . . . . 21

Housing, low income . . . . . . . . 28Conversion transactions . . . . 24 Property exchanged for . . . . . 17Personal property:Copyrights . . . . . . . . . . . . . . . . 2, 25 Publicly tradedDepreciable . . . . . . . . . . . . . . . . 30

securities . . . . . . . . . . . . . . . . 18I Gains and losses . . . . . . . . . . . 19Covenant not toSmall business . . . . . . . . . . . . . 18Transfer at death . . . . . . . . . . . 30compete . . . . . . . . . . . . . . . . . . 22 Indirect ownership of

Suggestions . . . . . . . . . . . . . . . . . 2stock . . . . . . . . . . . . . . . . . . . . . . 21 Precious metals andstones . . . . . . . . . . . . . . . . . . . . 24Information returns . . . . . . . . . . 32D

Property used partly forInherited property . . . . . . . . . . . 33 TDebt cancellation . . . . . . . . . . . 4, 5business or rental . . . . . . . . 4, 8Installment sales . . . . . . . . 29, 33 Tax help . . . . . . . . . . . . . . . . . . . . . 38Deferred exchange . . . . . . . . . . 11

Publications (See Tax help)Insurance policies . . . . . . . . . . . 16 Tax rates, capital gain . . . . . . . 34Depreciable property:Publicly traded securities,Intangible property . . . . . . . . . . 22Real . . . . . . . . . . . . . . . . . . . . . . . 30 Taxpayer Advocate . . . . . . . . . . 38

rollover of gain from . . . . . . 18Involuntary conversion:Records . . . . . . . . . . . . . . . . . . . 25 Thefts . . . . . . . . . . . . . . . . . . . . . . . 25Defined . . . . . . . . . . . . . . . . . . . . . 5Section 1245 . . . . . . . . . . . 25, 30 Timber . . . . . . . . . . . . . . . . . . 23, 25Depreciable property . . . . . . . 30Section 1250 . . . . . . . . . . . . . . . 27 R Trade name . . . . . . . . . . . . . . . . . 23

Iron ore . . . . . . . . . . . . . . . . . . . . . 24Depreciation recapture: Real property: Trademark . . . . . . . . . . . . . . . . . . 23Personal property . . . . . . . . . . 25 Depreciable . . . . . . . . . . . . . . . . 30 Transfers to spouse . . . . . . . . . 17Real property . . . . . . . . . . . . . . 27 Transfer at death . . . . . . . . . . . 30L TTY/TDD information . . . . . . . . 38

Related persons:Land:Condemned propertyRelease of restriction . . . . . . . 19E Ureplacement, boughtSubdivision . . . . . . . . . . . . . . . . 23Easement . . . . . . . . . . . . . . . . . . . . 2 U.S. Treasury bonds . . . . . . . . 16from . . . . . . . . . . . . . . . . . . . . . . 8Lease, cancellation of . . . . . . . . 2Empowerment zone . . . . . . . . . 18 Unharvested crops . . . . . . . . . . 25Gain on sale of property . . . . 20Liabilities, assumption . . . . . . 17Exchanges: Like-kind exchanges

Like-kind exchanges: ■Deferred . . . . . . . . . . . . . . . . . . . 11 between . . . . . . . . . . . . . . . . . 15Deferred . . . . . . . . . . . . . . . . . . . 11Involuntary . . . . . . . . . . . . . . . . . . 5 Loss on sale of property . . . . 20Liabilities, assumed . . . . . . . . 13Like-kind . . . . . . . . . . . . . . . 10, 30 Patent transferred to . . . . . . . . 23Like-class property . . . . . . . . . 11Nontaxable . . . . . . . . . . . . . . . . 10

Page 40

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